Monthly Archives: May 2013

Financing My Retirement Part 5 – Get better outcomes with Annuities and Life Insurance

Continuing with some guaranteed retirement income strategies and making the most out of your nest egg whether you’re selling your home or using other savings for your retirement income.

The goal of this blog is to discuss strategies with guaranteed income solutions that allow you to stay in control, decrease taxes, increase income and leave more to heirs.

In the previous blog we looked at the outcomes of some typical client income strategies and this is a continuation on that theme:

A lot of people feel that their home is the one thing that will be able to provide enough money to support them in their later years.  If you are planning to sell your house to use your nest egg for retirement income,  and/ or are looking for guaranteed safe ways to increase your income, annuities should be the first thing you consider.

Here are a few reasons why.

1. Interest rates are low: Traditional expectations were that interest earned on the value of a home and other saved assets would be enough to live on for life and the principal would pass on to one’s beneficiaries. Unfortunately, for many of us low interest rates don’t provide enough of an income to support a decent retirement.

2. It’s very likely that negative returns in the market can wipe out your retirement income nest egg:  Hoping to avoid a negative outcome in the markets is not a plan and unfortunately the math doesn’t lie. There are many sources you can go to to discover the dangers of negative returns on a stream of income. My favourite source is Dr. Moshe Milevsky Ph.D. Professor of Finance at the Schulich School of Business at York University who, over the years has done excellent research that quantifies the severe and rapid financial devastation that can result from a negative sequence of returns in your retirement years. If you’d like to learn more about  the technical aspects of this topic I’d definitely recommend you check his website. Also, his book Pensionize Your Nest Egg  is an important piece that details some practical methods of ensuring lifetime income.

3. Psychology: The reality is that the majority of people are more afraid of running out of money in their lifetime than of dying so financial planners and most of people who are retiring or expect to retire, need to rely on products and strategies that give lifetime income guarantees.  This is a basic and necessary need that allows everyone to actually sleep at night.

4. Pensions: Traditional defined benefit pensions provide guaranteed income for life but fewer and fewer people have access to pensions of this kind. Defined contribution plans are more common however they are mostly invested in the market so there is significant risk that your retirement nest egg will be wiped out or insufficient.

So what are the available options to replace these risks that can provide us with a personal private pension that’s guaranteed for life?

Option 1 : There are variable annuities which are excellent for savings years and provide a minimum  dollar amount of guaranteed income for life. These we touched on in part 4 of this series.

Option 2: Then there are annuities which also guarantee income for life.

A general overview of annuities and many of the benefits can be found here.  In general, annuities provide you with the best, tax friendly way of generating an enhanced income for life that is available today. Your annuity income is determined by a number of factors including your age and the prevailing interest rates. In general, the older you are, the higher the income you can expect. Your after-tax income from an annuity will generally be much higher than what you get from a typical GIC or other guaranteed savings and in fact, because most of the income from an annuity is tax-free, income tested benefits such as Old Age Security or the Guaranteed Income Supplement are less likely to be impacted, if at all!

A separate point but very important outcome for many people regarding annuities is:  that almost everyone buys annuities with guarantee periods so that when you pass away, all of the residual value  is guaranteed to go to your beneficiaries.

Here’s an annuity example: (Please note that these rates are like fresh bread, so they go stale very quickly. Contacting a licensed insurance broker will get you up- to-date information when you need it).

A sample annuity:  In March 2015, a 65 year old male can receive an income of $15,194.86*  for $250,000 every year, guaranteed for life. The taxable portion of this income would be a mere $1,712.87.

* (Please note that these rates are like fresh bread, becoming stale very quickly, so contacting a licensed insurance broker will get you up to date numbers when you need them).

Our same 65 year old may also wish that his capital stay intact so that on his passing everything goes to his beneficiaries. Buying a $250,000 GIC or term deposit today is certainly a valid option that is often used in these cases however, it will get him a fully taxable income of only $6,150 per year. The high taxation and low income may not be the best solution.

Combining an Annuity with life insurance: To replenish his capital if he were to buy an annuity, (also known as an estate preservation strategy), our 65 year old would have a higher annual income if he we to do the following, using the same money.

The first is to purchase a life insurance policy for the amount he wishes to replenish. The benefit will go to his beneficiaries tax free, fast and outside of the estate so there are also no probate taxes, fees or delays. He then buys an annuity to pay for the life insurance premium payments.  Interestingly, today $250,000 of life insurance would cost him $7,122.50/ year in premiums which is more than offset by the $15,194.86 income we saw above that he can get from a $250,000 annuity.

By combining the two ideas, the annuity payments will give him an income (which is the difference between the cost of the premiums and the income from the annuity). In this example, after paying the life insurance premiums our 65 year old gets an  income of $8,072.36 per $250,000.  This income is still higher than he would get using the same money for a GIC or term deposit but more importantly because most of it is tax free he has much more money in his pocket each year. He also dramatically lowers the risk of a clawback from any income tested government benefits he may be receiving such as OAS or the GIS.

Of course, when our 65 year old  passes away his beneficiaries will get the full value of his estate because of the insurance policy.  And, it’s an easy process for his executor, can remain private and confidential, probate taxes and fees are eliminated, and his beneficiaries receive the proceeds very quickly.

This strategy works in many situations and I like it because it can be adapted to include joint first or last to die options, be specific to your individual income needs, and can include an extremely wide variety of outcomes such as privacy issues, an uneven splitting of the proceeds that you may like to see happen etc.

Of course everyone’s needs and situations differ.  To learn more about what investment strategies best suit your circumstances please speak with your advisor.

And as always, if you have questions or would like to learn more please feel free to drop me a line anytime.