Annuity Investment Strategies
With interest rates so low, many people have dismissed annuities as a viable investment option over the past few years. However, with rising investment fees and the elimination of other tax efficient and guaranteed investment choices, the annuity product deserves a second look.
In its simplest definition, an annuity is an investment contract that provides a fixed payment amount over a period of time. This payment could be received monthly, annually or by some other variation and the fixed payment amount is guaranteed for either a specified length of time or for the life on the annuity owner.
When the annuity is paid out for as long as the owner is alive, this is commonly referred to a “life annuity”and is only offered by life insurance companies. Annuities payable for a defined number of years, known as “term certain annuities”, can be purchased from both insurance companies and other financial institutions. Both types of annuities have countless options and levels of guarantees that can be attached to them. Typically, the more options and guarantees that are included will mean the lower the monthly or annual payment amount.
The payments received from registered annuities such as RRSP or RRIF accounts are fully taxable to the recipient. Non-registered accounts however have the option of purchasing a prescribed annuity which can lower the taxation in a given year and often help to avoid Old Age Security claw-backs. The decision on which taxation model to select should be carefully reviewed to maximize your personal tax situation.
For the investor that wants zero risk in their retirement portfolio, a typical RRIF in a GIC or term deposit will currently pay them around 2% per year right now. By taking only the RRIF minimum each year, they are still drawing down against their capital quite heavily. For example – if the investor is 71 years old, their RRIF minimum would be 7.38% and with their 2% growth rate, the remaining 5.38% of their annual payments would come straight off the principle. As the capital shrinks each year, their income level would continue to go down. A similar portfolio value transferred to an annuity could provide approximately the same income amount (if not more) but simultaneously ensure that they don’t receive less each year or even run out of money completely.
A second scenario where an annuity may work is for the balanced investor who wishes to hold 50% of their portfolio in stocks and the other 50% in government bonds or GICs. While not always appropriate, they may produce higher income levels by purchasing an annuity with the 50% earmarked for fixed income and continue to take comfort in their zero risk mandate for this half of their portfolio.
The most common objection to the annuity product is that in the event of a premature death, there is nothing left for the surviving spouse and/or the children. As I mentioned above, you can add any number of guarantees or options to an annuity to ensure either continuing payments to the surviving spouse as well as a guaranteed payout amount to your children or other beneficiaries. With countless available options, it’s important that you receive a proper explanation of each one and carefully select the ones that are right for you.
While not for every situation, the annuity product is a great alternative for many situations. It’s important for those in the market for an annuity product to receive the best possible rate on any given day. Although interest rates and life expectancy tables are the same across the board, there is a wide variety of annuity rates being offered on any given day and providers will raise and lower the rates that they offer based on their current needs to raise capital. To ensure you get the best annuity product possible, make sure your advisor has the ability to quote the annuity desired across all carriers and then select the one right for you. Although this can take significant time and effort, it can produce drastic differences in the amount of lifetime income that you will receive.