How an annuity can help you in retirement

As baby-boomers approach retirement, they are looking for ways to turn their nest eggs into income.

One way is to buy a regular payout in the form of a life annuity, an insurance product.

“Only 25 per cent of Canadians have a defined-benefit pension plan. For the other 75 per cent, annuities make sense,” says Michael Ondercin, assistant vice-president of guaranteed investment products for Manulife Investments.

“In fact, annuities should be viewed as a type of pension for Canadians who don’t have one,” he says.

“RRIFs used to be the most popular retirement income product with Canadians, but life annuities have re-focused them on how important it is to have a lifetime income,” says Brian Taylor, vice-president of individual wealth with Sun Life Financial Canada. The market crash of 2008 was a good reminder that investments can inconveniently go down in value.

How do life annuities work? The basic premise is you give a deposit of, say, $100,000, to an insurer. In return, you receive monthly payments for life.

Clear enough, right? This is where simplicity stops and complexity starts.

You can only buy annuities through insurers. Life annuities are regulated by the federal Insurance Companies Act, and provincial legislation. Sun Life only sells annuities through its own agents and advisors. Some banks own insurance companies that sell life annuities from Manulife, for example, although not through local branches.

You can buy life annuities only through a life-licensed advisor, someone to guide you through the labyrinth.

Life annuities come with many options, or riders. The buyer-beware rule applies in spades. Understand all your options and shop around for the best deal. Once the ink is dry on some policies, they cannot be changed.

Options you can buy include life annuities available in single-life or joint-life.

Joint-life is usually used for married couples, so when one spouse dies, the survivor continues to get a percentage of the payments. It can be structured to pay whatever percentage the clients desire.

You can also buy guarantees, called “term-certain” options, which guarantee payments for a set period, such as 10 years. If you die before the 10 years is up, your beneficiary will get the balance of the payments. If you outlive the guarantee period, payments continue until your death.

All of these options affect your monthly payments.

“But the longer you live, the more you benefit. You cannot outlive an annuity,” explains Ondercin.

There are risks: Inflation, for one, because things cost more as time goes on.

Annuities are based on interest rates, so a period of low interest rates is not the ideal time to buy one. To determine the annuity’s price, insurers use gender, age and the amount you deposit.

The typical life annuity purchased by Canadians from Sun Life in recent years has been about $95,000.

That would give you about $7,000 per year, or $580 per month, for a 70-year old male, with a 10-year guarantee period. Because they live longer, women get paid less for the same annuity amount.

A $500,000 deposit buys you about $2,000 per month, or $24,000 per year.

Including a guarantee period lowers the payments, but eliminates the risk of losing money if the owner dies early.

“My mother died of cancer at age 65, shortly after buying an annuity. But the annuity she had was not set up properly. There was no guarantee period, so payments ended,” says insurance broker Steven Moranis, who was in the footwear industry at the time. He is now a life insurance and annuity broker, with about 200 clients.

“Here’s a useful rule-of-thumb: The more conditions you put on an annuity policy, the lower the payments,” he says. “But sometimes, lower payments with longer guarantees are in the client’s best interest.”

Says Ondercin, “We recommend that clients use an annuity in combination with other income streams. Annuities are useful for covering off your housing, food and other necessities.”

These websites supply useful retirement-planning information:

• HelpMySavingsLast.ca (Manulife)

• MyRetirementCafe.ca (Sun Life).