Lifetime annuities – deal or no deal

BY ANDREW STEWART

Annuities are another option for a place to put your hard-earned money and can be almost guaranteed with fixed annuities.

Anyone who spends their lifetime earnings and investing will eventually come across the term annuities. It seems like there is an endless possibility of options from annuities, which is similar to investment choices that also have a barrage of choices.

For simplicity’s sake, we will take a look at the more basic annuity. One that most individuals will probably be familiar with is the fixed lifetime annuity.

Annuity
The main benefit to a lifetime annuity is that the amount of monthly cash flow is guaranteed. Essentially there is no investment risk because you aren’t investing in anything. A fixed annuity can be immediate or deferred. That is, depending on your contract, you may start receiving annuity payments within a year of purchasing your fixed annuity or you may have the payments start at a later time. Deferred annuities typically start payments at retirement.

For example, Andrew is 65 and has $100,000 in his RRSPs and he is ready to take some income to supplement his retirement. Andrew shops around and gets a quote of $570.33 monthly income for life.

What makes an annuity fixed is that the insurance company promises that your money will earn a predetermined, fixed return per year for as long as you live.

Life annuities make payments to the investor for as long as the owner lives, and the insurance company keeps whatever is left when the owner dies. Some life annuities allow the owner to purchase a guaranteed term, meaning that if the owner dies before a certain date, the owner’s beneficiary receives the rest of the annuity payments but usually it’s a lump sum.

Pros

• Guaranteed minimum interest rate: A fixed annuity will never earn less than the guaranteed interest rate, regardless of how the insurance company’s investments perform.
• Premium protection: You cannot lose your initial investment, your premium, with a fixed annuity.
• Income for life: If you purchase a life annuity, you can never outlive your income payments.
• Lowest risk: Interest credited is not dependent on the performance of investments or stocks.

Cons

• No inflation protection: Growth is fixed and may not keep up with inflation. That means their actual value may decline over time.
• No capital gains tax rates: Money withdrawn from annuities are taxed as ordinary income. It does not get the benefit of lower capital gains rates.
• Penalties for early withdrawals: Because annuities are designed to help people save for retirement, if you withdraw money from an annuity before age fifty-nine, you will be subject to a penalty.

Would you take this deal?
If we take $570.33 and multiply it by twelve, we get an annual income of $6,843.96 per year. The only way Andrew gets his $100,000 back is to live long enough. So how long would Andrew have to live? It’s not perfect math but if you take a simple approach and divide $570.33 into $100,000, you get 175 months to get his $100,000 with no interest. That’s 14 and a half years. That put Andrew at seventy-nine and a half.

What if Andrew just put his $100,000 in a high-interest savings account earning 2% that would extend the longevity of the $100,000 to just over eighteen years of age 83. What about mutual funds or things that could earn higher potential returns? If you invested in something that potentially earned higher returns like mutual funds or Exchange Traded Funds (ETFs), you might be able to make the $100,000 last longer.

In the end, if you can tell exactly when you’re going to die, I could easily tell you which is the better deal? If Andrew knows he is going to live past 85, then it’s highly probable that the annuity will pay off over other investment options.