Don't Outlive Your Capital

The oldest “official” living person in the world is now 115 years old, although there was a recent unofficial report of a 127- year- old lady in China. While there have always been unique one-off examples of long lives, there are now more and more people living beyond age 100. Perhaps of more relevance is a report issued by Statistics Canada noting that there are now more than 5,000 people over age 100 in Canada, and a significant increase in those living into their nineties. This increase in life expectancy will no doubt continue on, as per a summary of the current “scientific longevity research”, noted in a recent issue of national Geographic. As well, people generally are eating better, looking after their health more diligently and seem to be maintaining a more regular exercise regime, so it appears that the trend will continue. This does, however, cause a financial concern when you reach retirement: how to effectively manage your personal financial resources to ensure provision of a sufficient and sustainable income for the remainder of your life. 

As a means of dealing with this “longevity concern”, more and more people could utilize a guaranteed life income, not necessarily for all, but certainly for a portion, of their retirement savings. For the last several years, the most often utilized approach for RRSPs has been to convert them to an RRIF and draw income from that source through your mid-90s. All such income is subject to tax as received. 

The combination of a high and progressively increasing minimum required withdrawal schedule and continued low interest rates and volatile equity markets, has caused the provision of a secure retirement income to become quite a challenge. This challenge is compounded by the timing of the start of withdrawals from your account to finance your retirement. If you are unlucky and start with a few years of negative returns on your capital, while at the same time drawing income to finance your retirement, you may not have sufficient remaining capital to generate the growth required to continue financing your desired income level.

 As noted, an alternative may be to convert all or a portion of your RRSP funds to a life annuity, which will provide a guaranteed income for as long as you live. This income, in combination with your OAS and CPP, could be set at a level to ensure a minimum income to cover your basic living requirements. The remainder of your investment holdings, such as TFSAs and non-registered investment accounts, could then be invested on a bit more aggressive basis to provide supplementary income and growth in capital to help offset future inflation and potential health-related financial requirements. 

A life annuity would be acquired from an insurance company and would generate a guaranteed income payable until death, whenever that may occur. You can add a guarantee period of up to 15 years, which means that even if death occurred soon after the life annuity was arranged, payments would continue for the remainder of the guaranteed period. Alternately, your estate could opt to receive a lump sum equal to the present value of remaining guaranteed payments. With a 15-year guarantee, the total of all the guaranteed payments would be very close to the amount used to acquire the original annuity. This means that, even in the worst case scenario where you don’t live beyond the guarantee period, you at least get your original capital back by way of monthly payments. In the best case scenario, where you live to a ripe old age, you will have the benefit of a long guaranteed income and the satisfaction of beating the insurance company. For a married couple, the annuity can be arranged on a joint and last survivor basis, again with a guarantee period of up to 15 years. Payments would continue until the death of both the annuitants or until the expiry of the guarantee period if both die prematurely. 

Another variation would be to arrange a life annuity where the payments would be indexed to increase annually, by say one, two or three percent per year, or possibly by an amount equal to increases in the Consumer Price Index. This would reduce your initial income level but would be offset by increasing payments over the remainder of your life, or lives, in the case of a joint and last survivor annuity. 

These payments are comprised of interest earned and a return of capital. The following chart roughly denotes the income payable for a $500,000 deposit for a few selected ages and annuity types as of early September 2013:  

Annuity Type	Age	Life - 15 years guaranteed	Life - 15 years guaranteed; indexed at 2%/year
Male	70	$3,119/mo	$2,642/mo
Male	75	$3,347/mo	$2,894/mo
Female	70	$3,347/mo	$2,470/mo
Female	75	$3,210/mo	$2,748/mo
Joint & Last survivor	70/70	$2,761/mo	$2,269/mo
Joint 7 Last survivor	75/75	$3,044/mo	$2,574/mo

The foregoing comments apply to life annuities from registered plans such as RRSPs, RRIFs, LIFs, and pension plans. When an annuity is acquired with non-registered funds, a very advantageous tax treatment is available as only a portion of the annuity is subject to tax.