Need a secure retirement income? Rising interest rates have weighed on pension payments
Along with GICs, annuities require a fresh look as interest rates soar.
Both are conservative, low-risk investments that have long been avoided by many people because their returns reflected consistently low interest rates. The rise in rates this year has significantly improved returns for both.
Annuities are insurance contracts where you pay a lump sum of money to an insurance company in exchange for a guaranteed monthly income stream for as long as you live. In a world where the majority of workers have no pension, annuities respond to the fear of running out of money.
Improvements in monthly annuity income over the past 12 months can be seen in the following examples of $100,000 annuities in a registered account, with payments guaranteed to last 10 years even if you die sooner (the money would go to your estate or your beneficiaries). The data was provided by Rino Racanelli, an insurance consultant specializing in annuities.
- A 65-year-old woman: $550.88 per month, up 15% from $478.90 12 months ago
- A 65-year-old man: $589.75 per month, up 15.6% from $510.10 12 months ago
The pushback against annuities starts with the fact that people don’t like to give up control of their money. You cannot unwind an annuity contract once you start receiving income. Solution: Use an annuity for only part of your retirement income.
The other criticism of annuities is that low interest rates drive down yields. Annuity payouts aren’t entirely dependent on rates – they also incorporate factors such as the age of the person buying the annuity and mortality credits, a term for the money left over when an annuitant dies over sooner than expected, then pooled for use by those who live longer than expected. But as the quotes above clearly show, rates matter a lot for annuities.
Inflation drives up interest rates – and the cost of living for everyone, including pensioners. It is possible to purchase annuities that increase payments to offset inflation each year, but the monthly payments are much lower. An example from Mr. Racanelli shows a difference of $2,400 per year between a registered conventional annuity of $100,000 and an annuity whose payments are indexed to offset a 4% inflation rate.
“It’s a huge drop,” Mr. Racanelli said. “What I’ve generally found is that it takes about 13 years to catch up on the payments you get without the inflation protection.”
His suggestion to clients who want inflation protection is to put some of their money in the stock market. Dividend growth stocks are a good starting point for inflation protection.
Mr Racanelli said interest in annuities has increased lately, but some people are waiting for higher rates to tie up money. time rather than making a one-time purchase. Example: Instead of a $100,000 annuity, you invest $25,000 in four separate purchases made each quarter. Mr. Racanelli said that in most cases there is a $10,000 minimum on annuity purchases.
At the end of June, guaranteed investment contract (GIC) rates reached 4.15% for a one-year term and 5% for five years. Annuity payments are based on a combination of principal and interest, so they cannot be directly compared to the interest-only payment performance of a guaranteed investment certificate. But it is always possible to calculate an approximate return from the annualized monthly payments of an annuity.
Using the above example of a 65-year-old woman, monthly payments of $550.88 produce an annual amount of $6,610.56 and a return of 6.6% on an annuity purchase of 100,000 $. Your actual yield, or yield, based on income separate from your principal, depends on your lifetime. It would take about 15 years of payments totaling $6,610.56 per year to recoup your principal. After that, you receive interest and mortality credits.
To increase the after-tax return of annuities, consider using non-registered money to purchase one. Annuity payments from a Registered Retirement Income Fund are considered regular income and taxed at your regular rate. With non-registered “prescribed annuities”, your payments are considered a flat combination of taxable interest and return of capital. Therefore, your after-tax amount would be higher.
A final note on maximizing annuity returns: It is essential to compare payouts from various insurance companies. Mr. Racanelli’s figure for the 65-year-old, the best available that day, was $26.02 per month above the lowest quote. Over 25 years, that works out to $7,806 before tax.
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