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Can you compare apples to apples with annuities and guaranteed investment certificates for retiring? Let’s find out.
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.
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