FINANCING LIFE Plan your retirement income stream
Retirement is the time to harvest your crop of financial assets. If you have a defined benefit pension, especially one that’s indexed, a lot of your problems are solved. Without an indexed DB plan, pension income will slowly fall behind the rising price level. Worse, if you have no job pension and you have to rely on savings, there is all the more reason to read on.
Retirement i ncome can come from fixed income assets such as bonds. Government of Canada bonds pay about 2% for 10 years and 2.7% for 30 years. Investment grade corporate bonds add 2% to 3% to federal bonds’ payouts. Guaranteed Income Certificates are in the middle with interest over government bonds and below corporate bonds. Finally, high yield bonds pay 6% to 8% more, but they are not called junk for nothing. Half of low end junk bonds will default before they mature. They do not furnish dependable retirement income.
Common and preferred stocks may yield 4% to 6% more than government bond income. They have desirable tax characteristics, for outside of RRSPs and TFSAs, their payouts qualify for the dividend tax credit that makes their income equal to straight interest plus a 30% to 45% boost, depending on province. Preferreds fix their payouts to a certain amount of money or link payouts to a specific formula. Common stocks pay what their companies directors wish.
Rising inflation harms prices of existing bonds whose interest rates, often set to lower inflation rates, become unattractive, thus pushing down the prices of these old bonds. But moderate inflation helps common stocks, for as the prices of what businesses sell rise with inflation, the earnings of the companies tend to rise as well. “There is a positive correlation of consumer prices and corporate earnings; moreover, most companies are nimble enough to adjust to moderate inflation,” says Marc Stern, vice-president and head of discretionary wealth management with Industrial Alliance Securities Inc. in Montreal.
Annuities promise to pay a fixed sum for a specified period, usually the life of the annuitant and often with a guarantee of at least 10 years of payments (thus giving the estate or heirs some money even if the annuitant dies prematurely). An annuity purchased for $100,000 for a 65-year-old man who does not smoke would pay as much as $545.20 a month, according to Cannex, a financial services database. That works out to $6,542 per year or 6.54%. It’s a lot more than a government bond offers and more than almost any investment grade corporate bond. They are fixed commitments of large insurance companies and therefore have no market risk.
The insurance company issuing the annuity adds a modest return of capital and makes a reverse life insurance bet that the annuitant will die relatively soon after the 10-year guarantee per- iod. The longer the annuitant lives, the less the insurance company makes.
Their downfall is that annuities usually do not pace inflation. These days, with bond interest low, it is not a terrific time to buy annuities. But if they are bought in a ladder, say 10% at 65, another 10% at 70, and so on, there is a good chance they can climb what is likely to be a trend of rising interest rates.
The final category of retirement income products are guaranteed income funds.
For a given sum, you get a guaranteed return, say 5% on your money from the time you turn some age — 65 is common, until you die. Unlike plain annuities, guaranteed income funds offer resets, so that if the underlying assets in which the funds are invested have thrived, you can reset to a higher base. Moreover, if you defer drawing income, you get a bonus.
“The problems with these GIFs are high annual fees — 3.0% to 3.5%, depending on the extras such as guaranteed minimum payments. The issuers disallow investment in straight equities in preference for less volatile balanced funds and bonds and may not return capital if they have not matched payouts,” says Ted Rechtschaffen, president of TriDelta Financial, a Torontobased wealth advisory firm. “In the end, these are expensive balanced funds with some downside protection. They are like annuities with a potential capital base reset, but they can burn up their capital and leave nothing after the owner passes away.”