Annuities Continue To Shine Despite Economic Downturn
I’ve always been a huge fan of annuities. I’ve helped retirees acquire them for over 27 years. During that time the feedback I’ve received continues to be extremely positive especially during these trying times and the uncertainty around the impact of COVID-19. With the Bank of Canada reducing its overnight rate along with the stock market demise, the spread of COVID-19 is having serious health and financial consequences for Canadian families, especially seniors.
For retirees or soon to be retirees who are concerned amid the volatility, buying annuities can be a comforting option. The latest research shows that when markets decline, retirees show more interest in annuities than they do during a bull market. This suggests the need for retirees to have a guaranteed retirement income remains.
An annuity is a steady stream of guaranteed income payments you receive in exchange for a lump sum of cash. A simple investment that has withstood the test of time, the annuity has a successful history dating back to Roman Times. Most annuities are purchased by retirees looking for a guaranteed retirement income they can never outlive. An annuity can be purchased with a guaranteed payout period attached to it ranging from 0-25 years. This means if the annuitant (the person who receives the income), dies within the guaranteed period then their chosen beneficiary will continue to receive payments throughout the remainder of the guaranteed period (to learn more about annuities and how they are structured refer to my article “Annuity Basics” published in February 2014).
During the past couple of years, I’ve been posting best annuity rates in Canadian MoneySaver. I show best rates for $100,000 annuity purchase with a 10-year guarantee for single and joint life annuity income amounts for males and females ages 65, 70, 75, and 80.
Let’s go back six publications and take a look at the amount of annual income annuities were paying, and compare that to today’s annual income rate.
Below is a comparison of annual income rates for a male age 70, $100,000 single life annuity with a 10-year guarantee.
December 2019......................... $6,492.00
January 2020.............................. $6,424.00
February 2020............................ $6,486.00
March 2020................................ $6,380.00
April 2020.................................. $6,400.00
May 2020................................... $6,358.00
The annual return ranges from 6.3 to 6.5% which looks real good, however, a big chunk of this is return of capital and if you outlive the other annuity purchasers you’ll be living off the return of their capital. The variation in income is not significant despite the fact that during the past six months not only have we seen short-term interest rates decline, but long-term bonds yields have dropped significantly. Most people over-estimate the importance of interest rates in determining overall income received from an annuity. The question then becomes how is annuity income calculated?
Each Canadian insurer calculates their own annuity rates using the following criteria:
- The amount of money used to purchase the annuity.
- The type of life annuity purchased.
- Current interest rates.
- The present long-term bond rates.
- The health of the annuitant.
- Insurance credits.
- Age of the annuitant.
- Gender of annuitant.
- Expense and mortality experience of the company.
- Source of funds used to purchase the annuity registered or non-registered.
The three main sources of annuity income are drawn from interest rates, return of capital and insurance credits. As annuitants receive income from the annuity the importance of interest rates decreases over time. It’s the insurance credits that make up the largest portion of the income payments. While higher short-term interest rates and higher long-term bond rates do translate into higher income received in an annuity, it’s not as great as people think. It’s the third point, insurance credits that have the highest impact on annuity income received.
A Simple Example Can Help Explain This Concept
A retiree pools $1,000 with nine friends and each of them earns 5% interest. In the first year the pool grows from $10,000 to $10,500, each member now has $1,050 at the end of the year. Now let’s say that in the second year one person dies. On death the member’s money goes back into the pool. The remaining members who are still alive will benefit from that scenario. This is what insurance credits can do in terms of increasing your annuity income. The insurance credits are calculated by company actuaries ahead of time and priced into annuity income that the retiree receives from the very first day.
Why Do Annuities Continue To Be A Good Retirement Income Option?
Canadians are living longer. According to Statistics Canada a 65-year-old male can expect to live to age 85, while females can live to age 87. With a growing number expected to live into their 90s while others will reach the century mark. Improved life expectancy creates a financial risk—the risk of outliving your savings. Since Canadians are living longer they need their retirement income to last longer. Selecting retirement income options is one of the most important financial decisions a retiree or soon to be retiree will make. Besides outliving their retirement savings, some of the major challenges seniors face today include; market downturns and low interest rate returns on guaranteed investment products.
If you are considering purchasing an annuity with your RRSP or RRIF, remember there is no access to your capital. You are giving it up for a guaranteed income for life. Although RRIFs are more flexible than registered annuities in terms of liquidity and investment choices, an annuity provides a steady stream of guaranteed income that never decreases regardless of market conditions and has zero management fees. By purchasing an annuity you give up some liquidity and flexibility, therefore it should be an important component of a larger investment plan. You should always have enough cash on hand for emergencies and other investment opportunities.
Annuity products have become more innovative with numerous options available and continue to be one of the safest investments around backed by the Assuris guarantee (see www.Assuris.ca).
Lastly, when purchasing an annuity product it is vital to shop the market. Once you purchase the annuity there is no turning back. You want to get the best return for your dollar.
Final Note: Since the COVID-19 pandemic, I’ve received calls from clients concerned about their life, disability, and critical illness insurance policies and if there will be any changes. At the time of writing, the notices I’ve received suggest it would be best to restrict all travel if you are considering applying for these types of insurance plans. Some insurers (not all) are postponing applications to individuals who have recently traveled to some of the most affected countries and any travel on cruise ships.
Several insurers have advised new applicants, who intend to travel, to wait 1 month after their return before applying. They must not have any symptoms consistent with COVID-19. If the potential applicant has tested positive for the virus, they need to be completely healthy again before they can sign an insurance application. It may be possible to re-evaluate the application two weeks following their return to Canada, which corresponds to the incubation period of COVID-19. The applicant will have to be in good health and symptom-free to be eligible. If an applicant has tested positive for the virus, (although the insurers believe the mortality impact to be low), they could continue to underwrite each application on an individual basis. The spread of COVID-19 is continuously changing their risk assessment. This information is subject to change as the situation evolves. Finally, some insurers have considered introducing new wording to deal with this pandemic, but this will hopefully be on a temporary insurance basis. Other insurers may offer their clients a break in premium payments because of the financial hardships created by COVID-19.
IMPORTANT: Check with your insurance agent for any questions or concerns you may. They will be able to give you the answers you need on an individual basis.
Rino Racanelli is an independent insurance advisor in Toronto. Email: racanelli@sympatico.ca