Retirement investing specialist breaks down features, limitations of annuities and investments in meeting retirees' needs
Late last year, Canada’s retirement income space got a little more crowded: aside from Manulife’s comeback into the annuities space, Desjardins unveiled the country’s first-ever suite of advanced life deferred annuities (ALDAs) for individual investors, offered through advisors.
That has raised many exciting possibilities, and undoubtedly an array of questions among Canadian retirees. One that springs to mind: how could annuities and ALDAs stack up against the mainstay approach of dividend investing?
“There’s a very distinct difference between an open portfolio and ALDAs or annuities,” says David Little, senior wealth advisor at Blue Oceans Private Wealth with iA Private Wealth.
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As Little explains, ALDAs are useful for clients aged 70 who are still working and might like to defer taking out income from their RSP as a RRIF until they’re 85 years old. But that benefit, he says, is dampened by the limited amount of money Canadians can put into them: as per the Canada Revenue Agency’s (CRA) webpage on ALDAs, the lifetime contribution limit for an ALDA as of 2023 is $160,000.
“Because it’s such a small amount of money, there’s not really that much application for them,” Little says. “It doesn’t give you enough gasoline in the fire, so to speak.”
According to the CRA, Canadians who purchase an ALDA and go beyond their ALDA dollar limit run the risk of being taxed on the ALDA cumulative excess amount. That tax amounts to 1% for every month the excess is left in the ALDA at the end of the month.
Because there’s such limited room to put money in an ALDA, Little says clients who want to work past 70 would still need to convert their RRSP into a RRIF. For a client already making a six-figure income, adding tens of thousands of dollars of income on top of that would create an additional tax bite.
With the drastic increase in interest rates since 2022, Little says life annuities have become more attractive than they have been in years. For retired investors who are concerned about the impact market volatility can have on their portfolios and ongoing income, the idea of getting guaranteed lifetime yield in the neighbourhood of 5% to 7% can be very compelling.
“If I do a million-dollar deposit on a single life annuity for 10 years, I could make about $72,000 a year from that deposit,” he says. “Normally when someone puts a million dollars into a RRIF, we’d recommend people look at a 5% withdrawal rate, so there’s a substantial difference between what you can comfortably take out of a RRIF as opposed to buying an annuity.”
Income isn’t the only guarantee a life annuity can offer. As Little explains, an annuity holder who dies within 10 years from the time their annuity payments start can get back the money they put in, less the amount they’ve already taken out in income. Investors who pass away after those 10 years have elapsed, he says, will benefit from a steady stream of income, but won’t have any residual value left for their estate.
“When you're looking at putting a million dollars in an annuity, and you've taken out let's say $700,000, you’d have $300,000 left,” he says. “Whereas if I took $50,000 a year out of my RRIF after 10 years, I could conceivably have one and a half one and three quarter million dollars now because of my returns on the investments.”
A retiree with a portfolio including dividend investments in a non-registered account, Little says, would only have to pay 33% of tax on the dividends, and only after they’ve exhausted some $24,000 of tax-free income. The yearly growth potential of that portfolio, he adds, means there’s a likelihood that the retiree would still be able to leave behind a substantial amount of assets for their family.
“The other thing as well is that investors don’t have to take money out of my non-registered investment account. If they do, they may want to take capital gains out instead, because that’d only be taxed at 25%,” he says.
“With an annuity, they wouldn’t have any choice. They must take income out of it, and they’d be taxed on it.”
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