RRIF or Annuity? How About Both
Converting 30% of your holdings to annuities is the best option for those without DB pensions
Last column we looked at the five ways retirees could enhance their income, as outlined in Fred Vettese’s book, Retirement Income for Life. Today, we’ll drill down on the specific and controversial “third enhancement,” which was partial annuitization at the point of embarking upon retirement (usually at 65).
This strategy is for the vast majority of private-sector workers who lack the traditional Defined Benefit plans that are still prevalent in the public sector. If you envy that kind of guaranteed-for-life pension, there is a compelling argument for annuities, or at least partial annuitization. That of course is why annuities have always been one of the two main choices you are confronted with when you have to wind up your RRSP at the end of your 71st year.
Since few people want to cash out totally and immediately pay tax on the whole chunk, the vast majority of people either convert to a RRIF or to an annuity, although it’s not well understood that you can do both: this does not have to be an all-or-nothing decision.
Indeed, Vettese’s call to partly annuitize 30% of registered holdings at the point you begin retirement is an example of partial annuitization. The other 70% would still be invested in an RRSP or RRIF, perhaps with a second round of annuitization closer to the traditional age of 75 or so. (Keeping in mind Vettese also calls for commencement of the annuity-like CPP benefits at age 70).
Don’t expect your own advisor, especially if he or she is compensated with a percentage of assets under management from your RRSP or RRIF, to agree on this recommendation to annuitize. (As we said in the book review, few of Vettese’s enhancements will be embraced by the average financial advisor). Fee-only financial planner Rona Birenbaum says that’s because asset-based advisors charge 1% or more of your portfolio each and every year whereas an annuity merely pays an advisor a one-time commission up front of 1.5% or 2%, and that’s it.
That may help explain the mystery about why annuities are less popular than you might expect, given their benefits. But if you lack what finance professor and author Moshe Milevsky calls a “real” pension, then annuities are one viable way to go, if only for a portion of your assets. And you’re starting to see the nation’s financial institutions paying a lot more attention to this topic. Late in January, RBC ran a blog that said 62% of Canadians aged 55 to 75 are worried they’ll outlive their retirement savings but only 10% use or plan to use an annuity to ensure they’ll have a viable lifestyle in retirement.
Vettese says only 10% of private-sector workers now have true DB pensions and this will continue to dwindle: 60% of existing DB plans are being closed to new members, so he expects the percentage to fall eventually to just 5 or 6%. That’s a lot of people without true pensions. If you want to see what that world looks like, read the book Nomadland, which depicts the dire state of thousands of North Americans who lost their homes and wealth in the financial crisis and have taken to the roads to live in RVs and do temp work for Amazon. With grey divorce on the rise and the demise of employer DB plans, their only reliable income source is Social Security, or its Canadian equivalent of CPP/OAS.
CPP/OAS and social security are in effect inflation-indexed annuities but were only meant to be one of three pillars of retirement. If you lack pillar two (employer pensions) it’s up to retirees to convert whatever wealth they have in pillar three (registered and non-registered savings), and create their own “personal” pension. Enter registered and non-registered (or prescribed) annuities.
Here I must admit that I personally am considering going this route in the near future even though I know interest rates are finally starting to rise and may rise further in the coming year or two. As Birenbaum explains in a YouTube video, how much you receive from an annuity is very much age-related and the later you start, the higher the mortality credits (which you get from pooling longevity risk with others).
My own advisor, who is NOT compensated by assets, argues in favour of delaying annuitizing for now given my age (64) and a rising rate environment, but retaining flexibility with ladders of two-year GICs maturing at various times; my situation could be revisited when conditions are more advantageous to annuitize.
In her video, Birenbaum tackles the GIC vs annuity issue head on but seems more inclined to come down in favour of annuities. To test out the impact of one GIC laddering strategy, Birenbaum compared cash flow from age 65 to 90 under three scenarios: full annuitization at age 65, half at 65 with the other half in a five-year GIC until annuitization at age 70; and finally, all in a five-year GIC until age 70, then half annuitized at 70 and the other half annuitized at 75. She found virtually no difference in outcome under these three scenarios. “Overlaying the analysis with a present-value calculation would have resulted in the full annuitization at age 65 being the winner.” Chalk one up for Vettese, although she cautions that the comparison doesn’t factor in potential changes in interest rates.
As an exercise, I asked Birenbaum to provide three quotes for a $100,000 registered annuity (joint-and-survivor, with 20-year guarantees) with payments commencing at age 65, 70 and 75. As you might expect, the longer you wait, the higher the payouts but they are not dramatically higher by waiting. At age 65, the annual income ranged from a low of $3,810 from one provider to a high of $5,071. If commencing payments at 70, payouts ranged from $4,133 for the low provider to $5,566 for the high one. And by waiting till age 75, the annual income rose from $5,306 in the low case to $6,447 in the best case. Keep in mind that, as is also the case when deciding to defer CPP or not, going earlier also means you have the use of the money earlier.
The actual process of buying a registered annuity is simpler than you might imagine: you would liquidate $100,000 worth of investments in your RRSP so the cash is available to transfer, then complete an annuity purchase application and fill out and submit a T2033 RRSP transfer form. That form is sent to your RRSP administrator, and they transfer the cash to the insurance company without triggering tax. Once all these preliminary steps have been taken, payments begin the month following the annuity purchase, according to Birenbaum.
Of course, there is some risk in waiting to annuitize, since doing so assumes markets will cooperate long enough for your RRSP or RRIF to grow in the meantime. That risk is one reason Vettese argues for partial annuitization as early as 65, if that’s your chosen retirement age.
But as soon as 65? Doug Dahmer, CEO and founder of Burlington-based Retirement Navigator (a fee for service planner specializing in customizing retirement income), says that’s “a pretty punitive way to create assurances of money lasting as long as you do.” He agrees with Vettese that “dollar cost ravaging” can deplete retirement nest eggs far faster than originally planned. However instead he suggests that “by simply creating or taking advantage of forward knowledge of how much money you need, when you need it and where to source it on a year by year basis you can put pension-like disciplines in place to protect against the variability” described in Vettese’s strategy.
You can learn more about Vettese’s strategy in this YouTube video conducted by Rona Birenbaum.
Jonathan Chevreau is founder of the Financial Independence Hub, author of Findependence Day and co-author of Victory Lap Retirement. He can be reached at firstname.lastname@example.org