Annuities and Retirement Withdrawals

Preparing for life after work. RRSPs, RRIFs, TFSAs, annuities and meeting future financial and psychological needs.
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Shakespeare
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Annuities and Retirement Withdrawals

Post by Shakespeare »

Jon's latest blog posting includes an e-mail from Moshe Milevsky. That e-mail is so important that I am going to take the liberty of posting it here in its entirety:
In 1994 Chris Robinson, Kwok Ho and I published an article entitled: "How to Avoid Outliving Your Money" in The Canadian Investment Review (CIR) – which predates all of the recent U.S. interest by more than ten years.

I believe we were the first to use Monte Carlo simulations jointly with mortality uncertainty -- which the current crop of U.S. researchers have yet
to embrace -- to argue that anywhere from 4% to 7% withdrawal rates can be appropriate, depending on precise age of retirement, gender, health, asset
allocation and the retirees’ RISK TOLERANCE.

Indeed, while you might NOT be willing to tolerate a 10% probability of retirement ruin, in exchange for being able to spend 5% of your nest egg, I
am more risk tolerant (or an unhealthy male) and am willing to take this chance. It is the classic risk/return tradeoff and is quite similar to RRSP
advice: One size does not fit all. Know your client applies here as well.

More importantly, the entire debate is frustratingly muddled by mixing "asset allocation" with "product allocation".

Remember that if I convert my entire RRSP into a life annuity at retirement, then the insurance company will pay me much more than 4% (of my initial premium) for the rest of my life, leaving me with absolutely no LONGEVITY
RISK. You can even get an inflation-adjusted or equity-linked life-annuity.

This is product allocation.

Yet, if I decide to avoid this product class and instead invest in traditional asset classes alone, I always run the risk of living too long and outliving my assets. Of course, that is the tradeoff for retaining control of investment and being able to bequeath this wealth.

So, you want to spend 7% of your nest egg, then go ahead, but make sure to annuitize....Ah, you hate the idea of annuitizing and you don't want more
than 60% stocks/equity? Ok, then you can spend no more than 4%.

Finally, the only benefit I can see from simplistically throwing-around this number 4% -- or for that matter any number - is that (a) it gets people thinking about their true needs, and (b) at least we won't have retirees planning to withdraw 10% of their initial nest egg, and expect to make it to
the end of the life-cycle.without starving!

I hope this helps...Feel free to cut-and-paste....moshe

Professor Moshe Arye Milevsky, Ph.D.
Schulich School of Business
York University, Toronto, Ontario
Sic transit gloria mundi. Tuesday is usually worse. - Robert A. Heinlein, Starman Jones
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Post by Shakespeare »

Now for some selected quotes:
Remember that if I convert my entire RRSP into a life annuity at retirement, then the insurance company will pay me much more than 4% (of my initial premium) for the rest of my life, leaving me with absolutely no LONGEVITY
RISK. You can even get an inflation-adjusted or equity-linked life-annuity.
I'm not sure where Moshe finds his inflation-adjusted annuities. But, an unadjusted annuity in combination with inflation-indexed CPP and OAS will give you a partially-indexed income.
So, you want to spend 7% of your nest egg, then go ahead, but make sure to annuitize....Ah, you hate the idea of annuitizing and you don't want more
than 60% stocks/equity? Ok, then you can spend no more than 4%.
I know steves will disagree. :wink:

Nonetheless, partial annuitization of some of the portfolio is something that many of us should consider.
Sic transit gloria mundi. Tuesday is usually worse. - Robert A. Heinlein, Starman Jones
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Post by Arby »

Is there a prescribed minimum withdrawal rate from an annuity that was purchased through an RRSP?
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Post by Shakespeare »

Is there a prescribed minimum withdrawal rate from an annuity that was purchased through an RRSP?
You hand the money to the insurance company and they give you an income stream that's fully taxable. The rates are set by current interest rates, longevity tables, the marketplace, whether or not they want to sell the product at that time, and the usual vigorish. But there is no "RRIF-equivalent" minimum withdrawal; it's an entirely different product.
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Post by ghariton »

Shakespeare wrote:Nonetheless, partial annuitization of some of the portfolio is something that many of us should consider.
Indeed. Most of my RRBs mature in 2021, when I will be 75. So I plan on annuitizing them some time between 65 and 75, depending on interest rates (a deferred annuity if available, starting at 75). Between the RRBs/annuity and CPP and my wife's small public service pension, my wife and I can live comfortably, with the occasional beer and bag of popcorn thrown in :wink: :wink: Everything else will be nice, but not essential.

One of my frustrations is the very limited number of quotes that can be found on-line, applicable to Canadians. They all seem to be either U.S.-based or access restricted to registered brokers and agents. Without such quotes, it is difficult to plan how much money I will need at 75, and therefore how much I can spend between now and 75.

Any useful links?

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Post by Bylo Selhi »

Shakespeare wrote:I'm not sure where Moshe finds his inflation-adjusted annuities.
IIRC feeonly.ca mentioned that RBC Insurance and Standard Life offer them.
while you might NOT be willing to tolerate a 10% probability of retirement ruin, in exchange for being able to spend 5% of your nest egg, I am more risk tolerant (or an unhealthy male) and am willing to take this chance. It is the classic risk/return tradeoff
Another problem with this tradeoff is that a high probability of success comes at a high cost, not only because of the low withdrawal rate, but also from regret that may arise from the high(er) probablility of leaving a substantial estate, perhaps even several times as much as one retired with.

(Of course those who want to leave large estates to their children may not see this as a problem, but someone who compromised the quality of their early retirement, e.g. by not travelling, might later regret their decision.)
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Post by Arby »

Shakespeare wrote:
Is there a prescribed minimum withdrawal rate from an annuity that was purchased through an RRSP?
You hand the money to the insurance company and they give you an income stream that's fully taxable. The rates are set by current interest rates, longevity tables, the marketplace, whether or not they want to sell the product at that time, and the usual vigorish. But there is no "RRIF-equivalent" minimum withdrawal; it's an entirely different product.
Are there any CRA rules regarding the terms and conditions of the annuity? The CRA RRIF Guide (T4097) describes a number of rules for an annuity held within a RRIF (including rules on the frequency and variability of the withdrawal amounts), but it's not clear if those same rules apply if the annuity is outside of a RRIF.
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Post by Shakespeare »

I can't access the CRA site right now, but here's what Google's cache has to say:
RRIFs that hold annuity contracts

Since 1997, a trusteed RRIF is permitted to hold the following two types of annuity contracts as qualified investments.
Locked-in annuity contracts

In this guide, an annuity contract is one that a licensed annuities provider issues (this is a person licensed or otherwise authorized under the laws of Canada or a province or territory to carry on an annuities business in Canada) and that meets all the following conditions:

* The contract provides that periodic payments be made on an annual or more frequent basis.
* The RRIF trust is the only person entitled to receive the annuity payments under the contract (unless the trust disposes of the annuity).
* Usually, the time and the amount of any payment under the contract cannot vary and must be based on the life of the RRIF annuitant. However, if the annuitant has elected to have the minimum amount paid to the annuitant's spouse or common-law partner after the annuitant's death, the payments can be based on the joint lives of the annuitant and the spouse or common-law partner.
* The starting date for the periodic payments is no later than the end of the year that follows the year in which the contract was acquired by the trust.
* The annuity contract must be one of the following:
o a life annuity for the life of the RRIF annuitant that does not have a guaranteed period that runs past the end of the year in which the annuitant reaches 90 years of age. If the RRIF annuitant had a younger spouse or common-law partner when the contract was acquired, the annuity can be for the joint lives of the annuitant and the spouse or common-law partner with a guaranteed period that does not run past the end of the year in which the spouse or common-law partner reaches 90 years of age.
o a term annuity with a term equal to either 90 years minus the age of the RRIF annuitant at the time the periodic payments start, or 90 years minus the age of the annuitant's spouse or common-law partner on that date if the spouse or common-law partner is younger than the annuitant.
* The periodic payments must be equal, unless they have been adjusted for one of the following reasons:
o in accordance with indexing;
o to reflect an increase or reduction in the value of a specified group of assets constituting the assets of a separate and distinct account or fund maintained for a variable annuities business by a licensed annuity provider;
o in accordance with a change in the interest rate on which the annuity is based, only if the new rate equals or approximates a generally available Canadian market interest rate;
o to reflect increases in the consumer price index, in whole or in part, as published by Statistics Canada under the authority of the Statistics Act;
o to reflect an increase in the rate specified in the annuity contract, not more than 4% per year;
o in accordance with an annual increase to the extent that the amount or rate of return that would have been earned on a pool of investment assets (available for purchase by the public and specified in the contract) is more than an amount or rate specified in the plan and provides that no other increase may be made in the amount payable; or
o as a result of a partial surrender of the right to receive periodic payments under the contract.

Top of page
Top of page
Other annuity contracts

These are contracts issued by a licensed annuities provider that meet both the following conditions:

* The RRIF trust is the only person entitled to receive the annuity payments under the contract. This does not apply after the RRIF trust disposes of the annuity.
* The annuity contract must give the annuitant an ongoing right to surrender the contract for an amount that, ignoring reasonable sales and administrative charges, approximates the amount that could be required to fund future periodic payments under the contract.
I think I'll let somebody else try to figure out what that means. :roll:
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Post by Bylo Selhi »

Milevsky wrote:Finally, the only benefit I can see from simplistically throwing-around this number 4% -- or for that matter any number - is that (a) it gets people thinking about their true needs, and (b) at least we won't have retirees planning to withdraw 10% of their initial nest egg, and expect to make it to the end of the life-cycle.without starving!
Numerous studies have shown that the 4% number is a good starting point. Of course, it's not some immutable law, but as Milevsky says, it's a good reality check to the 10% rates the fundcos have bandied about as gospel(*)

But more important is to realize that all the studies and simulations that I'm aware of use indexes, not actual funds, in their model portfolios. With the average fund charging 2.5% MERs plus hidden costs like brokerage fees and market impact costs, there's mighty slim pickings left for the retiree who wants a conservative withdrawal rate. Sadly, most people don't realize that the retirement that they're saving for may not be theirs.

(*) Templeton used to have a brochure that showed how a 10% withdrawal rate on a portfolio, consisting only of Templeton Growth, would lead to a prosperous retirement and a substantial estate. Of course that was then (when TGF was averaging ~14% a year) and this is now (when TFG has done 5.5% over 10 years, 10% over 15 and 9% over 20 years.)
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Post by gummy »

In '93, when I retired at age 59, I was about to have all my university pension money transferred to a LIF
(figuring I could do wonders, looking after the investments myself).

I argued with my wife who was silly enough to suggest that I put half into a life annuity.
A colleague at UW even suggested that, unless it were inflation-adjusted, inflation would kill me.
(He was an "expert", so that worried me ... until this.)

The Missus won.
Half went into a joint-and-last-survivor non-adjusted life annuity, guaranteed 15 years with 100% payments to the Missus when I drop dead.
The annual payments (in 1993) were $9.2K for every $100K annuity purchase.
Those were the days, my friend!

Now, a dozen years later, I realize how clever she was
... and she keeps reminding me. :D

http://www.moneysense.ca/rates/annuity_ ... /index.jsp
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Post by Feeonly.ca »

IIRC feeonly.ca mentioned that RBC Insurance and Standard Life offer them.
Actually RBC Insurance doesn't sell annuities at all.

With registered money you can buy CPI indexed annuities from Standard Life and Sun Life. You can buy escalating (2% - 5% /year increases) annuities from most any annuity provider.

With non-registered funds you can buy an annuity with prescribed tax treatment but the payments must be level.

One of my frustrations is the very limited number of quotes that can be found on-line, applicable to Canadians.
In Canada if you want to shop the annuiity market you will need to work with someone who is licenced and an independent broker/agent. I know a good one if you need someone :wink:
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Post by gummy »

In Canada if you want to shop the annuiity market you will need to work with someone who is licenced and an independent broker/agent.
Although you'd want a broker to actually BUY an annuity, it's easy enough to get estimates of annuity payouts on the Net.

In fact, in deciding when I should retire, I used the magic Excel formula:
=PMT(A, (B - age)/2, -100000)
to get an estimate of annuity payouts - depending upon your age and parameters A and B.

For the average of the annuities noted in the link I gave above, the following is pretty good:

Image
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Post by Shakespeare »

For the average of the annuities noted in the link I gave above, the following is pretty good:
Note that those are monthly payments per $100K, not percentages. :wink:
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Post by gummy »

... those are monthly payments per $100K, not percentages.
Aah, wouldn't it be loverly if'n they were percentages. :D

An interesting story:
In the Spring of 1993 I asked a couple of insurance guys to give me quotes.
One worked for Manulife, the other worked for what is now Clarica.
I said the annuity should start in September, 1993.

The guy from Manulife won with a quote that was $50/month larger.
However, he actually got me an annuity from Clarica (!), but had it start at the end of September, instead of the beginning of the month!

Clever, eh?
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Post by Arby »

Feeonly.ca wrote:With registered money you can buy CPI indexed annuities from Standard Life and Sun Life. You can buy escalating (2% - 5% /year increases) annuities from most any annuity provider.
Feeonly ... I am planning to annuitize my RRSP in a couple of tranches over a period of a few years, in order to mitigate interest rate risk. I was wondering if the annuity quotes will vary with amount that is being annuitized. For example, will I get a better annuity quote for annuitizing $500K than for $250K ? If so, could you provide a rough guideline as to how the annuity size affects the quote?
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Post by Bylo Selhi »

Arby wrote:I was wondering if the annuity quotes will vary with amount that is being annuitized. For example, will I get a better annuity quote for annuitizing $500K than for $250K ?
There should be a "quantity discount", just as there is with life insurance premiums.

Another thing to bear in mind is the limit of industry "insurance" on insurers, which is currently $2,000/month. If you annuitize at the rate of say, $700/month on a principal of $100k, then you may not want to buy more than $300k of annuity from any one insurer.
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Post by Feeonly.ca »

Feeonly ... I am planning to annuitize my RRSP in a couple of tranches over a period of a few years, in order to mitigate interest rate risk. I was wondering if the annuity quotes will vary with amount that is being annuitized.


Splitting the principal will lower the payout.

1. Commisions on the first $100k are higher than on the balance.

2. Each annuity has a policy fee.

Anything that adds to the cost for the insurer lowers the payout to the client.

For example, will I get a better annuity quote for annuitizing $500K than for $250K ?


Maybe yes, maybe no. Every insurer has their preference as to the amounts they want to sell. They price themselves accordingly and their preferences do change.
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Post by Arby »

Bylo Selhi wrote:Another thing to bear in mind is the limit of industry "insurance" on insurers, which is currently $2,000/month.
And another factor to bear in mind is the Claims Paying Ability of the company that is issuing the annuity. DBRS provides a Claims Paying Ability rating for some of the insurers.
The DBRS claims paying ability rating scale gives an indication of the risk that a borrower will not fulfill its full obligations in a timely manner. Claims paying ratings measure the capacity of an insurance company to pay its policyholder claims as they fall due.
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Post by ghariton »

Nice link, gummy, but it doesn't seem to show any inflation-indexed annuities. Do you have a link to any of those?

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Post by Shakespeare »

Sadly, the annuity rate link at Moneysense no longer works because of the new site. Does anyone have a Canadian annuity quote link?
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Post by Bylo Selhi »

Cannex only shows Male - 10 Year Guarantee - Non-registered for free :(
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Post by Arby »

There is an interesting interview with Moshe Milevsky about annuities on ROB TV archives. Scroll to the bottom of the page at 8:30 PM under Money Talk With Patricia.
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Post by Feeonly.ca »

There is an interesting interview with Moshe Milevsky about annuities on ROB TV archives. Scroll to the bottom of the page at 8:30 PM under Money Talk With Patricia.
Good find Arby, the interview is well worth viewing.

De-accumulation/income planning is significantly more complex than accumulation/investment planning.

Make an error in the latter, you can work longer to compensate. If you make a error in the former, you probably won't have enough time to repair the damage.
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Post by northbeach »

Shakespeare wrote:
Sadly, the annuity rate link at Moneysense no longer works because of the new site. Does anyone have a Canadian annuity quote link?

This should work:

http://www.canadianbusiness.com/my_mone ... /index.jsp

This is for joint 10 year with guarantee. Other a scenarios available, but not inflation indexed type.
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Post by Bylo Selhi »

northbeach wrote:This should work...
Thanks!
but not inflation indexed type
Not very common in Canada yet, however, Pension Envy, "I understand that some Canadian insurance companies plan to start offering indexed annuities."
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