At a time of ever longer lifespans, a cash-for-life form of retirement income makes great sense.
Annuities offer this deal, and so does the Canada Pension Plan. And yet both forms of retirement income are criticized for their low rates of return. People wonder why they should accept plodding returns on their contributions when they can do so much better investing on their own. Here's why: The certainty and security of cash for life is worth giving up some returns.
The return people get from the CPP was analyzed in a study issued earlier this month by a think tank called the Fraser Institute. The conclusion was that the after-inflation rate of return on your contributions is much better for older workers than for the young. The study says you will get a "meagre" 2.1-per-cent real rate of return from the CPP's retirement benefits if you retire at age 65 in 21 years or more, a real return of 3.6 per cent if you retired in 2015, 6.3 per cent in 2003, 12.6 per cent in 1989 and so on.
These discrepancies are due to a couple of factors, one being the fact that CPP contribution rates were raised over time to put the plan on a solid financial footing. People also originally had to work fewer years to collect full CPP benefits than they do now. Still, we're left with yet another generational inequity. Just as older Canadians have cleaned up in housing and the stock market, they've also made the most from the CPP.
Don't lose faith in the CPP because of this. It's not the deal it was, but it's still a valuable pillar of our retirement savings system. For one thing, an after-inflation return of 2.1 per cent is not horrible in our slow-growth economy.
A 10-year Government of Canada bond yields about 1.3 per cent these days, and that's before factoring in cost-of-living increases that clocked in at 1.3 per cent in March. The S&P/TSX composite total return index (includes dividends and changes in share price) averaged 3.1 per cent annually for the five years to April 30, and that's also a before-inflation number.
Maybe you or your investment adviser can do better than the CPP (you could also do worse). You'll probably have the chance to try your hand because the maximum annual CPP benefit this year is $13,110. Even with Old Age Security added, people will commonly need to save and invest more either on their own or through company pensions to have enough retirement income.
The CPP isn't a ton of money, but it's reliable. Contributions flowing in and management of this money through the CPP Investment Board will keep the benefits secure. You have no worries about all the glitches that can occur in your own investments, starting with neglecting to set up a consistent savings plan.
Those investing mistakes don't just cost you in terms of a reduced rate of return. They also affect how long your money lasts in retirement. One of the most important things you can do to destress your retirement years is to take away worry that you'll outlive your money.
The CPP is only a limited answer. That's why people planning their retirements should consider annuities as well for a portion of their savings. Put a lump sum into an annuity and you get monthly income for life. Payouts for annuities are influenced in part by interest rates, so they're not going to wow anybody. But, again, it's money for life with zero worries about corrections and recessions.
Aside from low rates of return, the knock on the CPP and annuities is that they can be a losing proposition if you die young and barely get to draw on your benefits. The CPP does have a survivor's benefit with limited room to shift benefits to a spouse, and it's possible to buy an annuity that pays some degree of benefits to your beneficiaries if you die within a particular range of time.
But unless your health history dictates otherwise, your time is much better spent on planning for a longer-than-expected life as opposed to a shorter one. Part of that planning process is understanding and appreciating the role of cash for life options like annuities and the CPP.
Rob Carrick