People who save through RRSPs have a choice to make when they retire. They can transfer their RRSP balance to an RRIF and draw it down at their own pace (subject to a minimum) or they can buy an annuity.
Buying an annuity seems like an elegant solution since it removes the risk of outliving one’s assets (what actuaries like to call “longevity risk”). It eliminates the hassle of making investing decisions after retiring and the income stream it provides is super safe (it really is, at least in Canada).
A 60-year-old male purchasing a single life annuity for $100,000 would receive an annual income of approximately $5,808. Not great if you live until 67, but by age 77 you would have recovered the original contribution and all of your income after that is in excess of your original purchase amount. If you live to 101, you make out like a bandit!
With the recent fall in long-term government bond yields, annuities now return more than 100% return of premiums paid in many cases. And annuities can come with generous survivor income options, if one is prepared to pay for them.
Annuities become increasingly attractive later on in your retirement (one of the few things that does).
Apart from money that is earmarked for bequests or the odd big ticket purchase, a sound strategy is to annuitize one’s wealth at about age 72. To understand why, let’s look at the minimum payout at age 72 under a RRIF. If the RRIF held $100,000 in assets at age 72, the minimum amount that would have to be withdrawn that year is $7,480. Many retirees are upset about this because they feel the minimum withdrawal rules force them to deplete their assets too quickly, especially in the current low-interest rate environment.
By contrast, an annuity that is purchased at age 72 with a single premium of $100,000 would produce annual income of about $8,382, in spite of low interest rates. Not only is this about $902 more than the minimum RRIF income, the annuity is payable for life and thus removes any chance your money will run out too soon. More income and less worry is a hard combination to beat.
Another reason to annuitize is to simplify your life. Let’s say your RRIF is invested 50% in equities and 50% in fixed income. Why not buy an annuity with half the money and then invest the remaining portion 100% in equities? The annuity replaces the fixed income investments and provides a perfectly stable income stream at the same time. You can do this at the point of retirement or later on, say at age 72, as a variation on the first strategy.