It’s easy to find advice about putting money into your retirement piggy bank. Far rarer are tips about how to get it out.
That’s a pity, because choosing the right option can mean a six-figure difference to the amount of income you collect over the course of your retirement.
For many Canadians, the problem emerges the year they turn 71. At that point, they must wind up their registered retirement savings plan (RRSP).
They have two options if they don’t want to immediately pay income tax on the total amount of RRSP savings they’ve accumulated.
Like most people, they can convert to a registered retirement income fund (RRIF). Or they can do what practically nobody does and buy an annuity.
Which is better? Surprisingly, the numbers favour the unpopular annuity.
You won’t hear this advice often, probably because buying an annuity means giving up control of your investments and handing over a large cheque to a life insurance company in exchange for a regular monthly payment. That doesn’t tend to appeal to the swashbuckler in us.
In contrast, a RRIF lets you maintain your existing portfolio of stocks, bonds and mutual funds – although you do have to make minimum annual withdrawals that grow bigger as you age.
The problem is that the flexibility and independence of a RRIF come at a considerable cost, according to Paul Goldstein, who runs an eponymously named financial services firm in Toronto.
He has constructed an example that demonstrates the eye-popping difference between the two options for a typical couple.
In his example, Joe, 71, and Jane, 69, have accumulated an RRSP portfolio of $1,000,000 and want it to generate a healthy retirement income that they can’t outlive. They are not in a position to take stock market risk, so they want to stick with fixed-income products and are dismayed to realize that, at today’s paltry rates, they can’t expect a yield much higher than 2 per cent.
Mr. Goldstein looks at the amount of income this couple will receive each year by sticking to an RRIF and compares it with what they would receive by buying an annuity that guarantees them an income for life.
He assumes they will choose an annuity with a guarantee period of 15 years. This means that even if both Joe and Jane are hit by a bus a day after starting their annuity, their heirs will receive the commuted value of the payments that would otherwise have been made until the 15 years are up.
In addition, he assumes their annuity will contain a provision that payments will fall in half after 15 years if either spouse dies.
At today’s rates, Joe and Jane could hand over their million-dollar nest egg and buy an annuity that would pay them $71,220 a year, with all the features mentioned above.
How does that compare with the RRIF alternative? Mr. Goldstein assumes that Joe and Jane will withdraw what is required by law each year. That varies from year to year and is calculated according to a formula based on the age of the younger spouse.
In the first year, Joe and Jane would have an income from their RRIF of about $48,000. That, of course, is $23,000 less than they would have received with the annuity.
And the annuity’s advantage keeps on growing. After 15 years, Joe and Jane would have pocketed total annuity payments of just under $1.1-million versus about $815,000 from a RRIF.
Since the annuity pays them a guaranteed income of about $71,220 a year as long as both are alive – or $35,610 if one dies after 15 years – they are always better off than under the RRIF alternative, which produces just over $26,600 a year in income by the time Jane turns 95.
To be sure, Joe and Jane will not leave a portfolio behind if they go the annuity route. People who are intent on leaving a large bequest often cite this as a reason to avoid annuities.
However, Mr. Goldstein’s numbers suggest this objection is overblown. For starters, whatever is left in the RRIF after both Joe and Jane pass on is immediately subject to tax. If the amount is large, the tax bite is likely to consume nearly half the cash left in the fund.
In contrast, the annuity will have generated far more money in total than the RRIF – and it will have done so in a tax-efficient manner, since the entire income would have been received year-by-year and thus been taxed at a lower rate. By Mr. Goldstein’s calculations, Joe and Jane consistently wind up ahead with the annuity.
Can you take issue with this conclusion? Sure – you can assume that Joe and Jane take the RRIF route and hit the right combination of buoyant stock markets and benign interest rates to leave them better off than with the annuity.
But that involves risk – remember the crash of 2008? – and, most times, annuities win. Fred Vettese, chief actuary at consultants Morneau Shepell, compared how annuities would have fared versus a RRIF invested equally in stocks and bonds over every 30-year period between 1938 and 2001 and found that in 30 of the 35 periods, annuities would have produced the higher income.
Mr. Goldstein says annuities deserve more of a role in retirement planning. It’s tough to disagree.
1. Consider your circumstances
Annuities offer good value for nearly all retirees, but they’re not perfect for everyone. People with extremely large portfolios and investing acumen may have the ability to take on market risk in a registered retirement income fund, says financial adviser Paul Goldstein. Those who have no resources beyond their registered savings and worry about having money for emergencies might also still find a RRIF has advantages.
Annuity pricing varies widely among companies. It’s not unusual to see one company offering monthly payouts that are 10 per cent larger than another’s for the same annuity product.
3. It’s not all or nothing
Fred Vettese, chief actuary at consultants Morneau Shepell, suggests that annuity skeptics may want to keep a portion of their RRIF savings in equities but convert the part that would otherwise be in bonds into an annuity.
4. You’re never too old
Unlike most things in life, annuity deals get better with age, Mr. Goldstein says. Annuities can make sense in your 60s, but as you pass 70, the advantages of buying an annuity become even more compelling as payout rates soar.
Editor's note: A previous version of this column stated incorrectly that even if both Joe and Jane died a day after starting their annuity, their heirs would continue to receive payments until the guarantee period of 15 years is up. In fact, their heirs will receive the commuted value of the payments that would otherwise have been made until the 15 years are up.