Do You Own GICs? It Might be Time to Consider an Annuity
The majority of Canadians are worried about outliving their retirement savings. Some of these people choose to accept a certain amount of risk in their portfolios in exchange for the potential returns that will allow them to meet their needs.
Others however are not willing to accept the market risks and volatilities and choose instead to hold their retirement savings in GICs or other low risk, interest bearing vehicles. These low risk investors still worry just as much about meeting their retirement goals yet don’t seem willing (or aren’t getting the right advice on how) to do something about it.
For many of these retirees, an annuity might be the ideal option yet very few Canadians are using or planning to use an annuity right now. Why is that? With our low interest rate environment, annuities have fallen out of favour yet the people that should be using them seem perfectly happy to accept the low interest rates that they’re earning in GICs. More than likely, the real reason most people who should be using annuities are not is the fact that they simply aren’t aware of them and the bank teller who sells them their GICs is unaware of or not allowed to discuss these options.
An annuity provides a predictable income stream that is guaranteed for as long as you live. They can be particularly helpful to guarantee the ability to cover your fixed monthly expenses and then you can use additional savings to fund travel and other elective expenses.
Purchasing an annuity is best described as purchasing a defined benefit pension plan. Once setup, you don’t need to do any follow up or management and much like a pension, your retirement income will come in every month as long as you live, regardless of what the stock market or interest rates do.
To help explain, let’s look at an example. Fred is a 65-year-old widow who retires next month from his business that he has run for the past 35 years. He has already sold the business to someone and will get a $500,000 cheque when the transition is complete. Since he poured all of his efforts and disposable income into the company over the years, he has no other retirement savings but also no debt. Fred worries about ensuring that his money will last as long as he does since his parents are both 85 and still healthy. He is also very wary of the stock market as he lost a bunch of money a few years back and would prefer to keep all his money in GICs and take on as little risk as possible.
Scenario 1 – Fred invests in GICs and earns an average of 2.5% per year in interest. Fred wants to guarantee income to age 95 (I’ve removed inflation from both scenarios for simplicity but it can be built in to both options). He would be able to draw $25,300 per year from his GIC portfolio and would run out of money at age 95.
Scenario 2 – Fred purchase a life annuity with his $500,000. The annuity provides a guaranteed lifetime annual income of $31,631 and Fred doesn’t have to worry about market risks or interest rate movements at all.
For the GIC option in Scenario 1 to break even with the annuity, it would have to earn 4.6% per year in returns – considerably higher than GIC rates right now and unlikely they’ll be that high anytime soon.
There are a lot of Canadians out there who would love to have the stress-free type of retirement planning that comes with a defined benefit pension plan yet still have all their savings parked in GICs. If you think that an annuity product might be a good fit for your retirement, take some time to learn more and get a quote. I would be more than happy to run an annuity quote for anyone interested as well, feel free to send me an email!