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Can you compare apples to apples with annuities and guaranteed investment certificates for retiring? Let’s find out.
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I’m 60 right now. And, if I buy an annuity for $100,000, it appears I can get about $510 per month, according to the best quote I see, which is $6,120 a year. If I take the same $100,000 and get 4.2% interest on it at current rates, I can take out $536 a month for 25 years, which is my life expectancy.
It seems a DIY approach is about the same as the annuity, with the caveat that I might live longer but I also might die sooner.
Do you agree with the numbers above and what would you advise on what is better?
—Mark
This is a good question, Mark. I agree with your numbers, and based on the way you’ve done your comparison, an annuity and a guaranteed investment certificate (GIC) appear very similar. However, there are some differences to consider. Once you’re aware of the differences, and how those differences align with you and your lifestyle, you’ll have a better sense of which one is right for you.
As you know, of course, annuities and GICs are not the same thing. An annuity provides a guaranteed income for life, or a set time period, and it can be purchased from insurance companies, agents and brokers. And a GIC is primarily a savings vehicle, which can be bought from banks, trust companies, credit unions and investment firms.
In most cases, purchasing an annuity means exchanging your capital—a lump sum of money—for a lifetime payment that is similar to a pension. It’s a fixed, guaranteed income for life, with no more worries about interest rates, stock market crashes, running out of money, etc.
On the other hand, purchasing an annuity means making a long-term commitment to an unknown future. And you will no longer have access to your original capital.
Consider this example: If you want to buy a new car, you can’t go to the insurance company and ask for a little extra money. It’s not your money anymore.
I’m guessing you’re thinking about GICs as an alternative because you’re aware of the longer-term risks associated with an annuity, and you may want to maintain control and flexibility over your money.
A GIC can give you a guaranteed income over the length of the term and control of your capital; however, there is no guarantee on future interest rates or a lifetime income. You may also find it difficult to draw a monthly income from a GIC portfolio. This will prompt you to create a GIC ladder with different maturity dates so there is cash available when needed. The laddered approach may have an overall return that is less than the five-year return you are using to compare to an annuity.
Think about the different ways you—and the world for that matter—may change in the next 25 years. Look at interest rates, inflation, your lifestyle and spending habits, and so on. Inflation is likely the biggest risk you’ll face when purchasing a life annuity.
If you purchase a $100,000 annuity, what other financial resources do you now have? What will be coming to you in the future? What can you use to deal with any changes in your life? It’s important for you to know the answers to these questions.
Those are a few general things to think about when comparing GICs to annuities.
But, what about you? What income do you need to support the retirement lifestyle you want, no matter what happens? Do you want to build your retirement portfolio based on guarantees, probabilities or a blend of both?
A portfolio based on guarantees is usually made up of GICs and annuities. Combined, they provide a sense of security and if you have enough money, you’ll never see your capital decline in value. The real risk, though, as mentioned above, is inflation. Will tomorrow’s dollar buy the same as a dollar today?
Most financial plans are based on probabilities—i.e., an equity investment will earn a certain rate of return over your lifetime. There are no guarantees. One risk, in the absence of a life annuity, is running out of money. And another risk is how you react when equity markets move up and down.
It is not uncommon to use a blend of both guarantees and probabilities when designing an income plan. For some people, their Canada Pension Plan (CPP) and Old Age Security (OAS) is enough of a guarantee, and others also have company pensions. If you don’t feel enough of your retirement income is guaranteed, the addition of an annuity or a GIC portfolio may make sense.
As we’ve just come through a period of low interest rates, most people have shied away from annuities, and this may change as interest rates increase. Before purchasing an annuity, consider the alternative of delaying your CPP and OAS to age 70. Both are indexed annuities for life.
If the combined income will cover your basic needs for life, then you may not need an annuity, or you can put off the purchase of an annuity until later in life when inflation becomes less of a risk with a shorter life span. Of course, this commentary is provided as a general source of information and is not intended to be personalized investment advice.
Allan Norman provides fee-only certified financial planning services through Atlantis Financial Inc. Allan is also registered as an investment advisor with Aligned Capital Partners Inc. He can be reached at atlantisfinancial.ca or [email protected].
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Would GICs inside a tfsa be tax free as opposed to an annuity?
I recently bought two annuities, and before I did, I completed a lot of research.
A few things the article didn’t mention.
Annuities are very tax efficient, assuming they are purchased with non-registered funds.
Money spent on an annuity obviously cannot be part of an estate. Once the owner dies, it usually stops. (There are some versions that pay out benefits.)
The “sweet spot” for buying an annuity is often closer to 70.
Now is a good time to buy an annuity as the bond market and interest rates have combined to drive up rates.
Annuity rates vary widely, as much as $50 a month per $100k. Cannex offers a comparison of different rates.
The author correctly identifies inflation over the long term as the biggest challenge to annuities.
It is very important to do the research to determine if annuities work for you. Buying one is an irrevocable, till-death-do-you- part decision.
In addition to GICs or annuities, a portion of the portfolio could be held in equities such as blue chip dividend stocks. The author hints at this by mentioning returns based on probablilities.
There’s money I need in the next 5 or 10 years, and then there’s money I don’t need until 15 or 20 years, so some amount of risk could make sense.
A layered approach such as that presented by Fred Vettese in his book is attractive. Taking some portion of savings an buying annuities at different times.
There are also term annuities in addition to life annuities.
It also depends how much time you want to spend learning about personal finance and how much time you want to spend managing your money.
I personally am happy doing more self-directed management until about age 70, then I don’t want to have to think about it or be stressed about it and rely on whatever my decision making skills might look like in later years.
The author also hints at but does not fully explain that you can’t get a 25 year GIC. You might be able to get a 5 year GIC at 4.2% but then when it comes time to renew, the rate could be anything including much lower. With an annuity you don’t need to ladder anything, and it covers you for life. With a GIC, you would need to ladder and that creates risk.