Rita Silvan, editor-in-chief of Golden Girl Finance talks with Canada’s top actuary and best-selling author, Fred Vettese, about the investment product we love to hate: annuities.
GGF: Why do people hate annuities?
FV: Only about 5 per cent of people who are in a position to buy one actually do. You’re handing over a percentage of your assets to an insurance company so you lose the potential return, something called the “opportunity cost”.
GGF: With low interest rates, annuity payments are also lower. When markets are returning double-digits, it’s tough to give up that potential return. What’s the case for buying one?
FV: It’s important to be prepared for the worst-case scenario. What if your investment return is at the bottom of the range for an asset mix of 50-50 stocks and bonds? In that case, you’re better off shaving some of your RRIF into an annuity. RRIF investments only outperform an annuity when investment returns do much better than the median.
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GGF: What are some other benefits of annuities?
FV: Unlike your own investments which can deplete faster, due to lower than median returns or faster spending, an annuity can pay out for as long as you live. That’s a big comfort, especially in down markets.
GGF: At what age should you think about buying an annuity?
FV: The first one around retirement and the second around age 75. Like wine, annuities get better with age because of something called a “mortality credit”. It’s there whenever you buy an annuity but it’s worth a lot more if you buy it at 75 rather than 65. This is because some annuitants in the pool will die early. Insurance companies price this into how much income they pay out. Even if you don’t buy one at 65, you should plan to buy one at 75 because of age-related cognitive changes.
If you wait until your 80s, you may never get around to it. Or, your children and grandchildren may dissuade you from doing so since it affects their potential inheritance.
“It’s important to be prepared for the worst-case scenario.”
GGF: Once you buy an annuity, that’s it. You can never access that money again. So, what percentage of one’s assets should go in?
FV: 20-30 per cent is a good start. If you put in less than 20 per cent, it doesn’t have enough impact on smoothing out your income. If you put in more, it might draw down your savings too quickly.
GGF: Is there a scenario where it’s not a good idea to buy an annuity?
FV: There are two: 1) If you believe that your life expectancy is going to be shorter than average, there’s no sense tying up your money; and, 2) If you buy a joint-and-survivor annuity, your fate is tied to that of your spouse for all time—not a great idea if the marriage is rocky.
GGF: A joint-and-survivor annuity pays out a smaller amount than a single-life annuity, so why buy one?
FV: On the death of a spouse, the survivor will lose a portion (or all) of the deceased CPP and OAS income. Buying a joint annuity that pays out at least a 60 per cent of the annuity to the survivor helps to make up the loss of income from CPP and OAS.
GGF: Interests rate may tick up from rock-bottom lows. Some annuities are indexed to inflation to help the annuitant retain buying power. What are your thoughts?
FV: Annuities with riders for inflation protection are costlier than those without. I wouldn’t buy one.
GGF: What’s the best way to go about buying an annuity?
FV: Not a lot of financial advisors recommend annuities, perhaps for the simple reason that, once they get their one-time sales commission, it leaves them with less of your money to manage. The best thing is to work with a broker to get the best rates. Financial planners can also sell them. Don’t go straight to an insurance company. Some people ladder annuities, the same way they do with bonds, by buying one every 5 years or so, perhaps to take advantage of increasing interest rates. Keep in mind that you’ll have to pay commissions each time though.
GGF: Thanks for this enlightening conversation on an often misunderstood product.
FV: My pleasure.