Annuities: Overlooked gems in retirement planning

Retiree couple budgeting

Defined Benefit Pension Plans are becoming increasingly rare in Canada and more rarely an option for members of the legal profession. That’s why Frederick Vettese, an actuary and partner at Morneau Shepell and author of Retirement Income for Life, suggests that annuities might be the answer for retirees who want the rewards of a defined benefit plan, namely: Income for Life. 

For retirees with some savings who also expect to collect benefits from the Canada Pension Plan (CPP) and Old Age Security (OAS), Vettese recommends converting about one-third of personal retirement assets into an annuity that provides income for life. 

Those planning for retirement should consider these four important steps to making annuities part of the plan. 

Step one. Understand how annuities work and how they enhance a retirement plan. 

An annuity is something that you purchase. In exchange for your money, you get a lifetime of monthly payments. In today’s dollars, every $150,000 that you spend purchasing an annuity creates about $8,250 in annual income. Vettese admits that “$8,250 a year doesn’t seem like a lot” but he is able to demonstrate how it can add up to a real game-changer over time because the amount is guaranteed for life. 

Step two. Know what kind of annuity to buy and when.  

There are two types of annuities; one is indexed for inflation and one is not. Vettese argues that the annuities that are indexed for inflation are not worth the additional cost for two reasons. 

  1. CPP and OAS are both indexed for inflation. So, a good portion of your portfolio will adjust to rising costs and, in both cases, you put the investment and longevity risk on the shoulders of the government. 
  2. Your expenses are likely to decrease as you age. Inflation may drive up prices but your monthly spending is likely to decrease in real terms. One should more or less cancel out the other.  

Vettese also recommends a “joint and survivor annuity” that continues to pay one spouse about 60-75 per cent of what is payable when they are both alive. And payments to the surviving spouse are guaranteed for life.  

Step three. Understand where annuities fit in.   

Many retirees will rely on three income sources. (1) Government Plans including CPP and OAS. (2) Personal savings in a Registered Retirement Income Fund (RRIF) and, (3) A portion of their assets turned into a “Joint and Survivor” annuity. 

Note that buckets (1) and (3) both provide some form of income for life with absolutely no risk to the retiree. Bucket (2) is the only place where the retiree is expected to manage investment risk and estimate his or her own lifespan. 

In Retirement Income for Life, Vettese recommends that retirees begin to spend the money from bucket (2) in the early years of retirement to effectively lower their overall risk level as they age. 

Step four. Combine annuities with delayed CPP benefits.    

Assuming that a retiree follows the order of events as described above, the goal is to steadily reduce risk and rely more heavily on government plans and annuities over time. To maximize the effect of CPP, Vettese suggests that retirees should be willing to use more of their own money to finance retirement up to the age of 70 in order to quality for the maximum CPP amount. Learn more about the advantage of CPP at 70.

Convinced that annuities are not something to overlook? Learn more about how annuities can help you create income for life, lower your overall risk level, and help you enjoy greater retirement income. Book an appointment with your Advisor and request your free copy of Frederick’s latest book, Retirement Income for Life – Getting More Without Saving More


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September 27, 2018