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  The Companion Advisor: Retirement Planning
Innovative strategies for a worry-free retirement
Annuities regain their popularity

Recent market volatility and lowering interest rates may be making some retired investors concerned about the future of their retirement income. Through innovative annuity strategies, you can receive a more worry-free retirement that includes a guaranteed income stream.

Annuities are one of the oldest, safest, and most reliable retirement income products in Canada. They can be purchased for a specific term or for life and come with many income options and guarantee periods. Life annuities, in particular, which can only be purchased through life insurance companies, remain one of the few ways to guarantee income for the rest of your life, thereby overcoming one of the biggest retirement concerns, that of outliving one's savings. This advantage alone makes annuities a terrific retirement tool for at least a part of your retirement portfolio.

Why aren't annuities more popular?

Annuity products in Canada have not received much attention lately due to the tremendous stock market boom and the sharp decline in interest rates in the late 1990s. However, the lack of interest in annuities arises more from a lack of awareness than anything else. Implemented properly, annuities can become the foundation of almost any retirement income plan.

Let's first dispel three common myths regarding annuities:

Myth 1: Current annuity returns are low because interest rates are low

Many people feel that purchasing a fixed income investment is not wise since interest rates are so low. Although it's true that short-term interest rates have fallen sharply over the past few months, long-term interest rates have actually increased since the beginning of 2001. This is great news for annuities as most are backed with longer-term bonds. Therefore, the returns produced by annuities are generally very competitive compared to typical, shorter-term, one to five-year GIC investments.

Myth 2: Annuities purchased with non- registered funds are not tax efficient

While it is a fact that annuities don't produce tax-efficient forms of income like dividends or capital gains, non-registered annuities purchased on a "prescribed" basis offer tremendous tax advantages over other fixed income products such as bonds and GICs. Prescribed annuities enable investors to evenly spread out taxable interest over the life of the annuity. GICs and bond investors, on the other hand, must report taxable interest, as it is earned; higher in the early years and less when the principal is eventually reduced. For example, a 65- year-old female who purchased a $300,000 prescribed life annuity would receive a higher income and report almost $200,000 less taxable income over the next 25 years (to age 90) than if she had purchased a GIC earning six per cent with no capital reduction over the same investment period.

In addition, by receiving annuity income and reducing the amount of taxable income to report, prescribed annuities give investors over age 65 additional tax benefits such as:

n keeping more of their Old Age Security (less clawbacks);
n increasing their property, sales, and age tax credits; and
n receiving an additional pension tax credit of up to $1,000 due to the annuities taxable status - this credit does not apply to the taxable income of non-registered GICs, bonds, or investment funds.

Myth 3: if I die, annuity payments stop and my loved ones get nothing

One of the biggest concerns people have when purchasing life annuities is the fear of dying soon after the annuity purchase and the loss of the invested capital for their family. Individuals can purchase a life annuity on a joint and survivor basis, with or without a guaranteed payment period, to reduce that concern. Although joint and survivor options and guarantee periods (e.g.. five, 10, or 20 years of guaranteed payments) add some financial protection for beneficiaries, it is true that the original capital invested is no longer available once the annuity is purchased. In addition, the added protection of joint annuities and payment guarantees will reduce the amount of income received - the higher the annuity guarantees the lower the annuity income. This might not be so bad for a person or a couple who doesn't want to leave anything behind, but many people do want to leave a significant estate to their children, possibly for education or to help pay off debt. One common way to ensure an estate benefit is available after death is through the purchase of life insurance or through other investments.

The investment funds annuity approach

An investment funds annuity, is an investment approach that combines the income advantages of annuities with the growth potential of investment funds. By utilizing an investment funds annuity investment approach, you will be able to ensure you receive a high guaranteed income for the next 10 years while still allowing a portion of your investment to grow for the future. The investment funds annuity approach is a great alternative for the retired individual who are currently investing in GICs or bonds for income and would like to:

- earn up to 10 per cent GIC-equivalent returns that are locked in for 10 years;
- receive up to 70 per cent more after-tax income than current GICs, pay less tax and maximize government benefits; and
- grow an investment portfolio for the future.

Setting up an investment funds annuity is easy. The investor splits their total investment between a 10-year term certain annuity for income and an investment fund product for growth. The percentage split between the annuity and the investment funds depends on your income needs but a 45 per cent annuity and 55 per cent investment funds split is a reasonable starting point. Since the investment funds are left to grow over the next 10 years, you may want to select a heavier weighting of equity funds to maximize growth. After the 10 years are over, the annuity income stops and the client will need to decide what they want to do with the investment funds portion - possibly starting a new investment funds annuity plan. An example is shown below (Note: the investment funds portion of the plan will be worth more than the total $300,000 amount invested if the investment funds produce a gross annual compounded return of at least eight per cent.)

Investment funds annuity
Investment Split
$135,000 Term certain annuity
$165,000 Investment funds
$300,000 Total
(at 6%)
10-year term
certain annuity
Total Deposit
Annual income amount
Annual income taxable portion
Annual taxes payable
Net after-tax annual payout
Equivalent before-tax GIC return
Note: This chart is based on a marginal tax rate of 45% and annuity rates as at Sept 1, 2001.
Investment funds
Total Deposit
After-tax value of investment funds after 10 years*:
At 6% growth rate
At 8% growth rate
In all cases
At 10% growth rate
At 12% growth rate
* Assumes annual taxable portion of fund return is 25% at a tax rate on the taxable portion of 32% with the balance taxed on surrender at a capital gains tax rate of 22.5% Annual taxes payable on the taxable portion of the fund return is paid through withdrawals from the fund. Rates of return shown are for illustration purposes only and are not guaranteed.

In a nutshell

Annuities are still a powerful retirement tool that should be considered for at least a part of your retirement income plans. They can provide the worry-free retirement income and high guaranteed returns that most retired individuals are looking for. Innovative concepts like the investment funds annuity are just one of the ways to use annuities in your retirement income plan. Now might be an excellent time to review your retirement portfolio and consider adding annuities to your investment mix. For more information on this type of product consult your investment advisor.

Michael J. Ondercin, B. Math, specializes in the development and management of fixed-income products at Manulife Financial including GlAs, MR, and annuities.

This article originally appeared in Forum Magazine, published by the Canadian Association of Insurance and Financial Advisors (CAIFA).

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