Using Annuities To Create Your Own Personal Pension In Retirement

The reason why retirement planning is so difficult is because the one variable we need to know – how long we have to live – is impossible to predict. Sure, we have mortality tables and family history to help guide us, but statistically speaking, half the population will outlive their median life expectancy.

That makes longevity risk – the risk of running out of money before you die – a very real threat to your retirement. And yet many Canadians ignore this threat by not saving enough during their working years; retiring before they’re financially ready, taking Canada Pension Plan benefits too early, withdrawing too much from their RRSPs, and so on.

Nearly half of Canadians are worried they won’t have enough money to live a full lifestyle in retirement, according to a recent survey by RBC Insurance. They interviewed 1,000 Canadians aged 55 to 75 about their retirement readiness and came out with some interesting findings.

The retirees, or soon-to-be-retirees seem to want it all, according to the poll, yet many will lack the savings to do so:

  • 80 percent want to live at home for as long as they can
  • 72 percent said it’s important to own a car.
  • 68 percent said it’s important for them to be able to travel at least once a year
  • 53 percent want to go out for lunch or dinner a few times a week

Having enough money to support their desired lifestyle is a real concern, highlighted by the fact that 62 percent of those surveyed are worried about outliving their retirement savings.

The one retirement income tool that didn’t appear on the radar was an annuity. Just 12 percent said they are using or plan to use one in retirement.

How Annuities Can Help In Retirement

An annuity provides a predictable income stream for life – much like how a defined benefit pension, CPP, and OAS pays benefits for as long as you live. Nothing protects you from longevity risk quite like a guaranteed lifetime income.

It’s puzzling why more Canadians don’t choose to turn even a portion of their savings into an annuity – to pensionize their nest egg, to borrow a phrase coined by financial authors Moshe Milevsky and Alexandra Macqueen.

Lack of knowledge around annuities definitely plays a role. While nine in 10 Canadians polled by RBC know they don’t need to invest their entire retirement savings into an annuity, just 28 percent know that an annuity doesn’t have to be managed once it has been purchased.

How Annuities Can Help In Retirement

Some other tips you might not have realized about annuities:

  • It’s possible to invest in an annuity using your RRSP and/or RRIF savings.
  • An annuity provides a predictable income stream for as long as you live, regardless of whether financial markets rise or fall.
  • You can stagger your annuity purchases to help increase payouts.

Annuity Payout Rates

Speaking of payouts, I thought it would be helpful to see some examples of just how much income to expect from an annuity based on several different scenarios:

Age Gender $100,000.00  $250,000.00  $500,000.00
65 F $    5,354.53  $  14,106.01  $  27,939.89
M $    5,902.14  $  15,458.49  $  30,339.23
70 F $    6,149.82  $  16,069.36  $  31,426.43
M $    6,795.94  $  17,669.89  $  34,346.74

-Single Life annuities
-Rates as of Jan 11, 2018
-Registered funds
-10 year guarantee period
-1 month deferral period (i.e. time between depositing the money, and receiving their first payment)
-Annual payment frequency

I’ll be honest; I perked up when I saw the payout rates were between 5 and 7 percent of the initial deposit. Now, keep in mind, those rates won’t increase with inflation each year, but it’s still a healthy (and guaranteed) amount to receive for life.

I mean, why wouldn’t a relatively healthy 70-year-old male not want to turn $250,000 into annual income of $17,669.89?

If he reached his median life expectancy of 84 years he would have collected $247,378.46 in annuity payments. Call it a break-even. But what happens if he lives until age 90 or 95? Now he’s come out ahead by $100,000 or $200,000.

Remember, we’re talking about protection against longevity risk. As tragic as it would be to get hit by a bus in the year you purchased an annuity, you won’t be around to curse the decision and, if you get a 10-year guarantee period, you’ve built in some protection for your beneficiaries.

Under-spending in Retirement

One last thing on the annuity puzzle. Some proponents argue that annuities not only protect against longevity risk, but also the risk of under-spending in retirement.

A U.S. study found that roughly two-thirds of retirees who have $150,000 in savings at age 65 tend to spend no more than they receive from guaranteed income sources, such as Social Security and pensions. They’re afraid to spend the lump sum because they value liquidity.

An annuity, being a guaranteed income source, would make it possible to spend a bit more freely in the early years of retirement.

Final thoughts

Annuities can play a vital role in your retirement planning by helping to mitigate the threat of outliving your money while providing a predictable income stream for life.

I’m not suggesting you turn every penny of your million-dollar portfolio into an annuity, but carving out a portion to create your own personal pension will add another valuable income stream that you never have to worry about managing in retirement.

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  1. Lj on January 23, 2018 at 7:43 am

    Questions: 1) what if you suddenly need access to the capital (critical illness etc)? 2) is there ever a way to cancel it? What penalties? Thanks!

  2. Alan H Rae on January 23, 2018 at 9:30 am

    I am not sure I like the annuity numbers. My impression was waiting longer to take the annuity would mean a much greater payout but if we take your example for a male at age 65 and compare for a male at age 70 the numbers work out as follows;

    Payout to age 100

    Taken at age 65 $1,061,865

    Taken at age 70 $1,030,380

    This would imply taken an annuity as soon as possible.

    • Echo on January 26, 2018 at 10:50 am

      Hi Alan, great comment and I liken it to a worker with a defined benefit pension wondering when to retire. If he or she hangs on and works another year or two, how much more monthly income will that add to their pension benefits? At some point there’s a trade-off to say “this is all that I need” and retire, in this case, or buy the annuity in your example.

  3. Grant on January 24, 2018 at 6:25 am

    Another approach I like is to buy a deferred annuity at retirement, say 65, which delays starting payments until your life expectancy, age 84. The amount of money needed to buy a deferred annuity is much less, of course, and you can make an estimate for inflation to buy the income at age 84 you need. Done that way, the annuity is a good hedge against longevity risk and can enable more spending in the early years of retiring knowing the added income will be there if you live longer than your life expectancy. If not, well, you’re not around to worry about it.

    • Echo on January 26, 2018 at 10:47 am

      Hi Grant, I like that approach as well – thanks for sharing!

  4. Ginette on January 24, 2018 at 1:50 pm

    Thanks for a thought provoking and useful article. We are certainly considering buying an annuity with part of our portfolio as we get older to buy that ‘piece of mind’. We are going in with our eyes wide open that if we die early / unexpectedly, the money will be gone (outside of the guarantee period) but we feel that is a trade off worth taking. In terms of having access to capital, that is what the remainder of the portfolio is for.

    • Echo on January 26, 2018 at 10:45 am

      Hi Ginette, your thought process here mirrors my own. Especially for those who don’t (or won’t) have access to a workplace pension (i.e. 2/3 of working Canadians, and growing)…pensionize a portion of your nest egg and secure some lifetime income.

  5. Rajesh on January 24, 2018 at 6:50 pm

    What factors to consider for an Annuity when using Rrsp/Rrif vs a Non registered account as source of funds.

    • Alexandra Macqueen on November 13, 2018 at 12:06 pm

      The tax treatment. When the annuity is purchased with registered funds (RRSP or RRIF), the monthly payments are fully-taxable income. When the annuity is purchased with non-registered funds, some of each monthly payment is considered to be the owner’s return of capital, and that portion is not taxable.

  6. Brenda on January 26, 2018 at 8:39 am

    My question is related to the differences for women and men. If a man and a woman purchase the same amount of an annuity why are the returns different?

    • Echo on January 26, 2018 at 10:40 am

      Hi Brenda, women have a longer life expectancy than men so the annuity pay-outs are slightly lower per year with the idea that a female will collect payments for 2-3 years longer than a male.

  7. Frank on February 1, 2018 at 7:46 pm

    Thanks for this good information. Can you let us know how income from an annuity is taxed in Canada, as part of it is a return of capital, but the rest is income, I think.

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