Hi, my name is Sheryl Smolkin. I’m a lawyer and a journalist. Today I’m pleased to be continuing the Saskatchewan Pension Plan’s new series of interviews with financial experts. My guest is Gordon Pape.
Gordon is an author of over 40 books, a newsletter publisher, journalist and all around financial guru. He writes regular columns for the Toronto Star and moneyville.ca among dozens of other media publications.
At age 75, he has just released a new book called Retirement’s Harsh Realities and it doesn’t look like he is planning to retire anytime soon. Today we are going to talk about annuities, and why an annuity purchase can be an important strategy for making your money last as long as you do.
Q. Everyone contemplating retirement has two key questions. How much will I need and how can I be sure I won’t run out of money? How would you answer these questions?
A. How much you need depends on the individual and the type of lifestyle you want to lead after retirement. A study done by Statistics Canada a few years ago found that people in their 70’s were spending about 95% of what they spent when they were in their 40’s. Yet conventional wisdom says you only need about 70% of your pre-retirement income if you want to maintain your standard of living. Based on those numbers it suggests that in fact you need more.
You need to look at your expenses in retirement and your sources of income such as CPP, OAS, an employer-sponsored pension plan if you have one and personal savings. There is no magic number.
You need to plan for the fact that people are living longer. Something to consider especially after the age of 80, is putting some money into a life annuity. It’s not a great place to put your money right now because interest rates are so low, but once the economy starts to pick up again and interest rates start to rise that’s the time to lock in a life annuity that guarantees you an income for as long as you live.
Q. Tell me how an annuity works.
A. You’ve saved money in a RRSP, you’ve converted it to a RRIF at 71 and the government requires that you draw down a minimum amount from that fund each year. As the years go by, unless you’re able to invest at a rate that keeps up with the rate of the minimum withdrawals, the value of the fund is going to eventually drop.
By the time you get to your early to mid 80’s, the depletion rate is too fast. You might consider using a chunk of you RRIF or all of it to purchase a life annuity from an insurance company, in exchange for a flow of income for the rest of your life.
The down side is you don’t have the money anymore. You won’t have an estate you can leave but it will be cash flow for the rest of your life
Q. Why have annuities fallen out of favour recently?
A. Low interest rates and the fact that people don’t like the idea of giving up their capital. They like to be able to control their money, so they can leave something behind for their children. When you buy an annuity you lose that possibility. However, you can buy annuity that guarantees the income for a certain period of time so if you die within the period your children will get some money.
Q. When is the best time to buy an annuity? Why?
A. The longer you wait, the more money you’ll get from the annuity. The company will pay you less money at 65 than 80 because your life expectancy is longer. If you can maintain a rate of return in your RIF around 6% then the optimum time would be within your 80’s.
Q. What questions should retirees and prospective retirees ask when they are shopping for annuities? What different kinds of annuities are available?
A. Research the amount of money that the various insurance companies are offering. There are tremendous variations in the rates that they are offering for the same kind of plan. There are annuity brokers who will do this for you and find you the best offer. There is no one company that consistently pays more than others. Desjardins has come up quite often, but not all the time.
It also depends on the type of plan – i.e. one company may offer money for a straight annuity with no guarantees, where as another company may offer a better rate for a joint and last survivor annuity which means it carries on until the last spouse dies
You also need to give some thought to the company itself – the solvency of each financial institution. There is an insurance fund that covers people in the event that their insurance policy goes belly up, but the fact is that you don’t want that to happen and don’t want to be forced on a fund that has limitations on it.
Q. What does it cost to use an annuity broker and who pays them?
A. The fee will be paid by the insurance company that you eventually do the business with. It’s like a mortgage broker.
Q. If someone came to you for financial advice, what portion of his assets would you advise that he put into an annuity?
A. It will depend on the individual and how large an estate they want to leave.
Q. What are the downsides of annuities?
A. The solvency of the company. Also, if you don’t get inflation protection, over a length of time obviously the purchasing power of the income that you receive is going to decline.
Inflation protection is expensive, in the sense you will get a lower monthly payment than if you do not have inflation protection. On the other hand it will guarantee that as the rate of inflation rises over the years, so will the annuity.
There are also “impaired annuities” for annuitants with a terminal illness. The annuity pays more because the purchaser has a shorter life expectancy.
Q. Would you invest in one yourself?
A. No, not at this point. I am managing my money well enough, and my wife and I have sufficiently large RRIFs that we don’t feel we need to buy that kind of insurance at this time of our life. Down the road when I am in my 80’s I may take a look at it.
Thanks Gordon. It was a pleasure to chat with you. I think Saskatchewan Pension Plan members will be very interested in your comments about annuities. They have the option of purchasing a competitively-priced annuity from the plan until age 71.