Gail Bebee is the author of No Hype - The Straight Goods on Investing Your Money. She can be reached at firstname.lastname@example.org and her website is www.gailbebee.com. This is part 10 of a 12-part series for people that are new to investing on their own.
Most of us contribute money to our registered retirement savings plans (RRSP) for years and years without giving much thought to what happens when it's time to take the money out.
When you collapse your RRSP, what you do with the money is one of the more critical decisions you will make about your retirement finances. So, it pays to fully investigate the options available well in advance of when you'll plan to take action. Don't wait until you are forced to make a decision because you need the money or turn 71, the age at which you must collapse your RRSP. You could make a hasty decision you'll later regret. Furthermore, you may need time to make changes in your RRSP holdings to implement your desired plan.
Many people take the path of least resistance: they roll the investments in their RRSP into a registered retirement income fund (RRIF) at the same financial institution, and arrange for the regular withdrawals required by the government. But, what if the investments in your RRIF perform poorly or you live longer than you planned for and you run out of money? What happens if inflation destroys the purchasing power of your RRIF withdrawals? What if you are no longer able to manage your finances? Fortunately, you can transfer these risks elsewhere by buying an annuity with your RRSP proceeds or other savings.
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An annuity is an insurance contract. You pay a specific sum of money to an insurance company and, in return, receive regular income payments for a specified time period.
To address the risks identified above, you'll want a life annuity, which is one that provides payments for the rest of your life, and one that adjusts the payments for inflation. The inflation adjustment is usually a percentage of the annual change in the Consumer Price Index (CPI). An annuity which does not cap these annual increases provides the best inflation protection.
Annuities are available in a variety of options. For example, you can buy a life annuity with a guaranteed payment for a specified minimum time period whether or not the annuitant is, or the annuitants are, alive. A joint-and-last-survivor life annuity pays as long as one of the two joint annuitants (such as a husband or wife) is alive. The cost of such features reduces the monthly payment you receive.
Annuity payments are based on mortality tables, so the older you are when you buy, the higher the monthly payout. This also means that a woman receives a lower payout than a man of the same age, since women live longer.
Annuities reflect interest rates at the time of purchase. Given the current rock bottom interest-rate environment, payments are at the low end of historic ranges. However, you can buy any number of annuities with your RRSP proceeds. You could stagger annuity purchases over time or move money into a RRIF and wait for better rates before buying.
An insurance company with a superior financial strength rating and positive outlook is paramount. You want the firm to be around to pay you for the rest of your life. Life insurance companies must be members of Assuris, the not-for-profit organization that protects Canadian policyholders if their life insurance company should fail. Assuris guarantees annuity payments up to $2,000 per month or 85 per cent of the promised monthly income benefit, whichever is higher.
Once purchased, annuities are irrevocable, so do your homework before buying. Hiring a financial adviser to help you navigate through the pros and cons of all the available options for collapsing an RRSP will likely be money well spent.
If you do decide to buy an annuity, obtain quotes from a number of insurance agents and be sure you understand how the person selling you the annuity is compensated.
The many Canadians without employer-sponsored pensions should definitely consider annuities in their retirement plans. It's like having your own personal pension. Even those with pensions should take a look because an annuity can fill retirement income gaps. For example, it could add inflation protection or ensure adequate ongoing income if the spouse with the pension dies.
As employer-sponsored pension plans continue to disappear from the Canadian landscape, it becomes more and more important for Canadians to fully understand and plan for the financial side of their retirement. Annuities are one option for generating retirement income. Do take the time to investigate this complex financial product. It could be just what you need to enjoy your retirement years.