Most Canadians in or near retirement are concerned about running out of money in old age, surveys show. And statistics suggest they’re right to worry.
Canadians are living longer, meaning not only that their money has to cover a longer retirement period, but also that they’re more likely to reach the age at which they’ll need costly long-term care. At the same time, fewer retirees can count on the kind of generous company pension that guarantees a certain level of income for life.
Younger Canadians, who are likely to live longer still and even less likely to have a pension, have even more reason to worry.
Ottawa, though, is promising a new financial product that experts say could help people stave off the risk of outliving their retirement savings. Last year’s federal budget introduced so-called advanced life deferred annuities, or ALDAs, with a start date of 2020.
Annuities pay out a certain amount of money beginning on a set date and are one of the investments Canadians can buy with funds held in a number of registered retirement accounts such as registered retirement savings plans (RRSPs) and registered retirement income funds (RRIFs). Currently, annuity payouts must start by age 71.
With an ALDA, however, Canadians would be able to defer payouts until the end of the year they turn 85.
This could make annuities significantly cheaper and more attractive, experts say.
How ALDAs would work
Individuals would be able to hold ALDAs worth up to 25 per cent of their registered retirement holdings, for a maximum lifetime dollar value of $150,000.
The value of the ALDA would not be included in the math the government uses to calculate how much seniors over 71 must withdraw from their registered retirement income funds (RRIF) every year, meaning Canadians would be able to keep more of their money in their RRIFs for longer.
Annuities are “mortality protection,” said Bonnie-Jeanne MacDonald, director of financial security research at Ryerson University’s National Institute on Ageing.
“You’re basically pooling your mortality.”
There are a number of similarities with regular insurance. Take auto insurance, for example. Individual premiums form the pool of money from which insurers draw to cover car accidents. But if you never get into a car crash, all you get for your monthly payments is the intangible benefit of peace of mind.
Similarly, with an annuity set to start paying, at, say, 71, all you get is peace of mind if you happen to die before your 71st birthday. On the other hand, the longer you live, the more bang you’re going to get for your annuity buck. Insurance companies use pooled funds to help pay those who survive their peers.
But with car accidents, as with death, insurance works best when it covers unlikely events.
The trouble with annuities is that Canadians today have a rather good chance to live to 71, said Alexandra MacQueen, a certified financial planner and co-author of the book Pensionize Your Nest Egg.
“I don’t actually want the insurance at 71. I’m pretty sure I’m going to live to 71. I’m worried about living to 90 or 95 or 100.”
ALDAs could be cheaper annuities
That’s where ALDAs would come in. The later in life you start getting the money, the higher the probability you won’t be receiving payments for very long.
All this makes it easier for insurance companies — the only purveyors of annuities that pay for life — to make the annuity math work, said MacQueen. That, in turn, would enable insurers to offer ALDAs for cheaper.
For example, based on the current U.S. annuity market, with around $195,000, a 70-year-old could buy an annuity that pays out $1,000 a month for life starting immediately. But with the same amount of money, the same retiree could get $3,500 a month starting at age 85, according to calculations by MacDonald and Branislav Nikolic of CANNEX Financial Exchanges.
“Put differently, by giving up the first 15 years of payments from age 70 to 85, a 70-year-old retiree could get the same income protection from age 85 until death at less than 30 per cent of the cost of buying an annuity that starts at age 70,” MacDonald said via email.
But will Canadians buy them?
Annuities have gotten a bad rap in North America. In part, many retirees are loath to hand over control of their money, MacDonald said. In part, annuities have become expensive as interest rates have been trending lower.
Interest rates are one of the main factors that determine how much income you’ll receive from an annuity based on the amount you put in. That’s because financial institutions use interest rates to predict how much they can earn by investing your money.
Cheaper ALDAs could help make annuities more popular, MacDonald said, but much will depend on who decides to buy them.
ALDAs make the most sense for Canadians who think they have a good chance of living past 85. But MacDonald worries that if only uber-healthy seniors buy into the new annuities, costs wil climb.
Pricier ALDAs, on the other hand, may turn off some potential buyers.
“You then get fewer people buying it, which drives up the price even more,” MacDonald said. “It’s kind of a catch-22.”
Much will also depend on how insurance companies package the actual ALDAs once they become available, MacQueen said.
Some annuities, for example, come with options to pass benefits onto a surviving spouse or transfer payments to the estate upon death. But the more bells and whistles you add, the more you’re going to drive up the cost of the annuity, MacQueen said.
To be sure, it’s still early days. Ottawa hasn’t introduced final draft legislation on ALDAs yet, but “the Canada Revenue Agency will administer the measure based on the draft legislative proposals,” Finance Canada told Global News via email.
Whether ALDAs will fly or flop remains to be seen, both MacDonald and MacQueen said.