Financial planner Robb Engen recently tackled this conundrum in his Boomer & Echo blog: “Why Canadians are avoiding one of the most misunderstood retirement tools.” Engen points out that experts like finance professor Moshe Milevsky and retired actuary Fred Vettese imagine that “turning a portion of your savings into guaranteed lifetime income is one of the smartest and most efficient ways to reduce retirement risk.” Vettese said the mathematics behind a pension is “pretty compelling,” especially for those without defined profit pensions.
Milevsky and Alexandra Macqueen coined a terrific term for pensions after they titled their book on the topic, which I reviewed within the Financial Post in 2010 under the title:A cure for pension envy?”
Engen notes that a lifetime annuity is “the cleanest version of longevity insurance…You give an insurer a lump sum and it guarantees you a monthly income for life. If you live to be 100, the insurer pays you. If the stock market crashes, you get paid anyway. If you’re 87 and never want to look at a portfolio again, the income keeps flowing.”
In other words, pension insurance neutralizes the 2 major risks that plague retirees: longevity risk (the prospect of living beyond one’s own money) and return risk, i.e. the chance of suffering a stock market crash early in retirement and causing irreversible damage to a portfolio.
Despite all of the seemingly positive features of an annuity, Engen notes that “almost no one buys one.” He cites a Vettese estimate that only about 5% of those that could buy an annuity actually accomplish that. Engen points out that there’s a behavioral hurdle: the fear of losing liquidity and control over the underlying assets. He cites a study by Bonnie-Jeanne MacDonald of the National Institute of Aging on pooled risk retirement income, by which she wrote that such retirees “strongly oppose voluntary retirement payments because they want to maintain control of their savings.”
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A probability to lock in recent portfolio gains?
Nevertheless, the brand new Retirement Club, founded earlier this yr by former Tangerine advisor Dale Roberts (see the blog (published alone website in June), a recent guest speaker extolling the virtues of annuities was Phil Barker of online annuity company Life Annuities.com Inc.
Barker said many consumers have told him that they’ve done very well within the markets during the last 20 years and that they’d now prefer to take a few of those profits. They could also be in search of fixed income strategies, and plenty of were glad with GIC returns after they were barely higher than they at the moment are (some were within the 6-7%) range. However, they’re less glad with the brand new rates of interest on GICs, which at the moment are reaching maturity. Meanwhile, pensions have just reached a 20-year high in November 2023, so there has never been a greater time to give it some thought, Barker told the club in August.
With annuities you may set an rate of interest for the remaining of your life. So if you will have good timing, it’d make sense to allocate a number of the funds to them.
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Related Reading: GICs vs. pensions
According to Barker, eight life insurance firms offer annuities in Canada: Desjardins, RBC Life Insurance, BMO Life Insurance, Canada Life, Manulife, Sun Life, Equitable Life and Empire Life. All are covered by Assuris, a third-party organization that guarantees 100% of a pension of as much as $5,000 per thirty days. So if considered one of these corporations fails, the pension could be paid by considered one of the opposite corporations via Assuris.
Barker described a pension simply as a “personally funded pension”. To start one, you may take registered or unregistered funds and send the capital to an insurance company. In return, you receive income for all times: that is the standard annuity. Unlike pension plans within the US, you may’t add funds to an existing pension plan, Barker told the club, nor are you able to mix funds from, say, RRSPs and unregistered funds.
However, you purchase a brand new annuity every time you would like it. In contrast to life insurance, there is no such thing as a medical insurance with pension insurance. Joint pensions for couples are of great value, he said, but tax receipts are sent to the first annuitant. Income splitting can be impossible under current CRA rules.
When pensions shine
Pension insurance shines when you’re confident in your health and your prospects for an extended life. Having a secure income of $X,000 a month to live to tell the tale will will let you survive your other sources of income as they fluctuate with the stock market, Barker said. “We see people getting 6.5% to 8.5% per year for the rest of their lives, depending on their age.”
As Dale Roberts noted during Barker’s talk, if you will have enough to live to tell the tale from retirement funds alone (pensions, annuities, CPP/OAS, etc.), you will have the liberty to take some risk in other areas, akin to stocks and stock ETFs.
Funding through registered vs. unregistered accounts
Tax-free transfer of registered funds to a pension; This is because money isn’t deregistered, but flows from one registered environment to a different registered environment. It can be fully taxed upon publication. The monthly income from the pension is then fully taxable within the yr by which it’s received.
If you deposit with unregistered money, the taxation is significantly different. For one thing, in case your unregistered account has unrealized capital gains, you’ll have to comprehend them and pay taxes on them. Otherwise, so-called compulsory pensions are relatively tax efficient. The capital used to fund the pension isn’t taxed, only the profit, says Barker. “Therefore, the taxable portion of pension income is a very small amount. Mandatory means that taxation is the same or the same throughout the life of the pension.”
The club also has other retirement income products covered that is likely to be much like annuities in some respects: the Vanguard Retirement Income Fund (VRIF) and the Purpose Longevity Fund, each of which I even have small interests in. Dale adds that the Longevity Fund has the potential to be a “nice complement to pensions” because it is “designed to increase payments quite nicely in the later years thanks to mortality credits. Those who live very long are subsidized by those who die much earlier.”
