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Most of us worry about dying too young. In fact, living too long also poses a challenge. Especially if you're building your retirement planning around the assumption that you'll live an average life span, money is going to be awfully tight if you're still alive and kicking into your 90s and beyond.
The odds of you making it that far are better than you might think. For instance, if you're a woman and you've made it to 65, you have almost a 30% chance of living into your 90s. If you and your spouse are both 65, there's a 50% chance that at least one of you will make it to 90.
So how do you ensure that you're not living on a pittance if you happen to be the next Methuselah? A fortunate minority of Canadians enjoy what are known as defined benefit pensions. If you're one of those lucky people, you don't have to worry. Your pension plan will keep paying you as long as you draw breath.
Unfortunately, most of us don't have that cushion. If you're in that group, I recommend you think about an annuity.
The simplest kind of annuity, called an immediate-fixed annuity, is a bit like an instant pension. You hand over a wad of cash to an insurance company, typically when you're 65 or older. In return, the company agrees to write you monthly cheques for the rest of your life.
Nothing could be more straightforward — but annuities aren't popular. A lot of people are put off by the cost. A 65-year-old man would have to pay $400,000, for instance, to buy an annuity that pays around $30,000 a year for the rest of his life. To make matters worse, that payout is not indexed to inflation. If you want payments that rise with inflation, your initial income is much less.
Furthermore, if you get hit by a bus six months after buying your annuity, your heirs may be out of luck. If you didn't pay extra for a guaranteed minimum period, the insurance company would keep your $400,000 and that would be that. "Most clients don't like the idea of relinquishing control of a nest egg that's taken a long time to build," says Barb Garbens, president of Toronto planning firm BL Garbens Associates. "They think they can do better on their own."
So why do I like annuities? Because if you use them properly, you can maintain control of the bulk of your savings while dramatically reducing the odds that you'll run out of money.
The trick is to dump only part of your money into an annuity, says Chris Robinson, a finance professor at York University's Atkinson School of Administrative Studies in Toronto. Put in just enough so that your annuity payments, when added to what you get from Canada Pension Plan and Old Age Security, provide an income sufficient for your minimal needs.
You can invest the rest of your savings in a standard retirement portfolio, and you can still get at that money for health emergencies, round-the-world trips, or to help out the kids. But because of the safety provided by your annuity, your regular retirement portfolio can be more aggressive to provide some inflation protection. That means you probably don't need to pay extra for an indexed annuity, especially since your spending tends to decrease as you get older, says Robinson. Best of all, thanks to your annuity income, you can make smaller withdrawals from your regular retirement portfolio, particularly during nasty markets, which is when nest eggs can get crushed.
All of this will significantly reduce the odds that you'll run out of money. A study published in 2001 by John Ameriks, Robert Veres and Mark J. Warshawsky called "Making Retirement Income Last a Lifetime" found that if you set up a conservative retirement portfolio consisting of 20% stocks, 50% bonds and 30% cash, and you made inflation-adjusted withdrawals of just 4.5% of your portfolio every year to live on, your money has only a 33% chance of lasting 30 years. However, if you leave half of your money in that portfolio and plop the other half into an annuity, your portfolio has more than an 80% chance of surviving to 30.
You should look at an annuity as longevity insurance, rather than as an investment, because the payout doesn't depend on the markets, it depends on how long you live. Like most insurance, you don't get any great benefit from it if you never have to use it — that is, if you don't live longer than average. But if you can still blow out the candles on your 90th birthday cake, an annuity could be the best investment you ever made.
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Duncan Hood was MoneySense's features editor from 2004 until 2008. Prior to joining MoneySense, he was the editor of Strategy magazine. |
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