Concerned about your lifetime cash flow? It all starts with your needs
How do you provide retirement cash flow that will last for as long as you live? First, ask yourself: what will you need the money for?
ESSENTIAL EXPENSES
Food, shelter and clothing are essential for survival. Utilities and insurance premiums are essential. As you age, medical expenses and long-term care can become essential expenses, too.
For essential expenses it’s good to have the steady cash flow that comes from Old Age Security (OAS), Canada Pension Plan (CPP), a defined benefit employer pension and a life annuity. All these cash flow sources are guaranteed to continue paying for your lifetime.
DISCRETIONARY EXPENSES
Some expenses are not necessary for survival. Entertainment, vacations, gifts and donations are examples of discretionary expenses. As much as you may love to go on winter vacations you probably don’t have to head south each winter.
To pay for such discretionary expenses you can withdraw savings from your Tax Free Savings Account (TFSA) and Registered Retirement Income Fund (RRIF).
As you get older, your essential expenses increase while discretionary expenses decrease.
REMEDIES
Are you worried that you won’t have enough savings and pensions to cover your essential expenses? Maybe you can delay your retirement or work parttime after retirement. Maybe you can rent out part of your home. Consider selling or downsizing your home to free up capital to invest.
To make your savings last for your lifetime, consider using RRIF savings to buy a life annuity.
LIFE ANNUITY
A life annuity is a contract with a life insurance company. You pay a lump sum of money to the insurance company in exchange for regular monthly payments for as long as you are alive.
A life annuity can generate a high guaranteed lifetime income due to ‘insurance credits.’ Actuaries predict how many people in a large age group will survive each year. The life insurance company takes on the longevity risk when it makes a contract to pay you lifetime income.
Each annuity payment consists of interest, a return of capital plus insurance credits. Out of a large pool of annuitants who are the same age as you, some will die sooner than average. The unused balance of their annuities stays in the pool as insurance credits. Those who die too soon subsidize the annuity holders who live too long.
For example, a 65-year-old man who invests $100,000 today could receive an annual income of $5,818 for the rest of his life, of which about a third is due to insurance credits. Pooling the risk enables the insurer to make payments for as long as you live.
ANNUITY DISADVANTAGES
Inflation erodes the purchasing power of annuities. RRSPs have been around for 60 years. Annuities were the original mandatory RRSP retirement income option for the first 30 years. Due to the double-digit inflation of the 1980s and the desire for flexibility, RRIFs eventually became the dominant RRSP retirement income option for the next 30 years.
The most common misconception about buying an annuity is that, in the event of death, there will be nothing left for the surviving spouse. That’s why it is prudent to buy an annuity with a guarantee period. For example, annuities can be guaranteed to pay for 15 years or until the death of the surviving spouse.
ANNUITY ADVANTAGES
The owner of a life annuity doesn’t have to make re-investment decisions. This becomes important if you are afraid of losing your mental capacity due to dementia in later years. Think of buying an RRSP annuity as an alternative to giving one of your children a power of attorney to manage your RRIF.
Terry McBride, a member of Advocis, works with Raymond James Ltd. The views of the author do not necessarily reflect those of Raymond James Ltd. Information is from sources believed reliable but cannot be guaranteed. This is provided for information only. We recommend that clients seek independent advice from a professional adviser on tax-related matters. Securities offered through Raymond James Ltd., member of the Canadian Investor Protection Fund. Insurance services offered through Raymond James Financial Planning Ltd., not a member of the Canadian Investor Protection Fund.