Dear Silver Lady,
A friend of mine put all his retirement savings into an annuity and said we should too. What exactly is an annuity?
Janice
Dear Janice,
I often get asked about annuities, so let’s talk about this strategy. Life annuities are designed for clients with insufficient savings or who have a very low tolerance for the risk of investing in the market.
There are four main types of annuities: single life, joint life, fixed term and deferred.
Straight life annuities are the simplest. This guarantees periodic income for life with payments starting immediately – less a bonus.
Be careful with this one. This annuity pays the highest amount for life, but when you die, payments stop and there are no estate payments.
Joint and survivor annuities last as long as either partner is alive. There are a few options with this: You can purchase an income-reducing annuity that is less expensive, whereby the joint annuity payment decreases on the death of the first spouse.
There is also an option in this plan to guarantee payment of the premium if you choose a cash payment provision. On the death of the annuitants, the difference between the premium and the payment can then be paid to the beneficiaries.
Term annuities are generally the ones I prefer. Payments are made for a fixed period, whether or not the annuitant dies. If you use your RRSP/RRIF funds in a fixed term annuity, payments generally only last until age 90.
You can manipulate your term from three to 40 years and most are very flexible. A cashable option is only available with this type of annuity since the convertible value can be easily calculated at any time.
The last type of annuity is called deferred annuity. With this plan, customers can take advantage of a slightly higher interest rate by purchasing the annuity years earlier than needed.
You will be encouraged to pay a higher premium during the deferral period, allowing interest to accumulate in the product and therefore increase the overall value on the agreed conversion date when it transitions to a paying annuity.
Now, before you all rush out to buy an annuity, let me go over some of the downsides. Most annuities cannot be cashed or changed after income payments begin. Payments often cannot be adjusted to reflect changing needs, and funds are not accessible in emergencies.
Remember that you are giving ownership of your investments and control of your capital to the annuity. It can never be used as loan collateral or reallocated.
Annuities are great for helping diversify a retirement portfolio, but it’s always a good idea to use them with other investments that offer more flexibility, like RRIFs and TFSAs.
Good luck and best wishes,
silver lady
Christine Ibbotson is a national radio host and author of three books on finance, including the Canadian bestseller “How to Retire Debt Free & Wealthy”. His latest book, “Don’t Panic — How to Manage Your Finances and Financial Anxieties During and After Coronavirus,” is available at bookstores across Canada. Visit askthemoneylady.ca or send a question to [email protected].
