As retirement nears, the focus changes from building your nest egg to converting it into income. But how can you avoid outliving your money?
This is a vital concern, particularly when you’re looking at 30 or more years of retired life. Drawing down the capital and investment return from a registered retirement income fund, generating income through bonds or guaranteed investment certificates (GICs) or even just gradually withdrawing money from your bank account are all ways to turn your savings into income. But all of these carry the risk of your capital running out before you die.
- How long might you need your money? Get an estimate with this life expectancy calculator.
One way to generate an income that’s guaranteed for life is to buy a life annuity from an insurance company. You pay the insurer a certain amount of money, and the insurer commits to paying you a specified monthly amount for the rest of your life. Annuity income is not affected by market volatility, which is one reason annuities are an attractive retirement income option. This annuity calculator will give you an estimate of your guaranteed retirement income with an annuity.
You can use money from a defined contribution (DC) plan or registered retirement savings plan (RRSP) — or non-registered money to purchase an annuity. If you use money from your registered account, you are taxed on the entire annuity payment in the year you receive it. When you use non-registered funds, only a portion of each periodic payment is taxable.
Timing your purchase
Monthly payments are higher if you purchase an annuity at a later age, because the insurance company assumes the payout period will be shorter.
As well as interest rates (which affect the investment return the insurance company will achieve with your money) and your life expectancy at the date of purchase, your payments are calculated by taking into account “mortality credits” — the effects on your insurance company’s pool of annuity funds of other annuity purchasers who die earlier than expected.
There are some important conditions to be aware of. Once you commit to the terms of an annuity, it cannot be changed. On your death (or in the case of a joint annuity, on the death of the last surviving annuitant), there is no death benefit payable to your beneficiary beyond any guarantee period.
That’s why it’s important to understand and choose an annuity that works best for you. For example:
- A life annuity will make payments as long as you live.
- A joint life annuity will make payments as long as either you or the second person (the joint annuitant — commonly a spouse) lives.
- Single and joint term-certain annuities for a specific period are also available that will pay the balance to your beneficiary if the last surviving annuitant dies before all benefits are paid.
What’s a guaranteed period?
You can also choose a guaranteed period such as 5 or 10 years. This means that if the last annuitant dies during the guaranteed period, a death benefit will be paid to your beneficiary. The longer the guarantee period is, the smaller your regular cheques will be.
If you opt for an annuity that defers income for up to 10 years in the future, your annuity payments will also be higher. However, if you use a DC plan or RRSP to purchase any kind of annuity, payments must start no later than the end of the year in which you turn 72. (This follows the mandatory deadline for collapsing RRSPs, which is the end of the year in which you turn 71.)
Where leaving an estate is your priority, you can use just some of your retirement savings to buy an annuity. For example, you can calculate how much you need to cover monthly expenses over and above the income you expect to receive from the Canada Pension Plan (CPP)/Quebec Pension Plan (QPP) and Old Age Security (OAS) and other pensions, then buy an annuity that pays just enough to bridge the gap.
This approach will allow you to invest the balance of your nest egg in a diversified portfolio of stocks, bonds and other investments that is consistent with your risk tolerance and that you can leave to your heirs.
Buying an annuity could be part of an integrated strategy to convert your retirement assets into the streams of income you need for a secure retirement. Your financial advisor can help you develop a customized plan that meets your personal objectives.