Cautioning against 'slippery slope' in tax optimization, retirement income planning specialist suggests other use cases
According to Desjardins’ official annuity product information materials, ALDAs allow retirees to put off their annuity payments up to the end of the year in which they turn 85. Other optional features, like a joint and survival annuity option and a cash refund option, create even more possibilities for people to optimize their retirement income planning.
In a statement announcing the launch last week, Philippe-Olivier Dumas, Section Manager, Product Development, Guaranteed Investment Funds and Annuities Team at Desjardins said ALDAs give advisors “an additional tool … to help clients manage the risk that they might run out of savings in their later years while deferring taxation.”
Annuities key to jumpstart retirement spending
While ALDAs could certainly fill a gap in many Canadian retirees’ financial planning, it might be too much to expect them to go stampeding into those income solutions, according to Adam Chapman, a certified financial planner and founder of YESmoney in Ontario.
“I doubt most people, advisors included, even know what an ALDA is, let alone an annuity. And if they do, they don't often have the best opinion of them,” Chapman told Wealth Professional. “Understanding the value of guaranteed income is one of the steepest hills retirees have to climb on their journey toward spending money.”
As a financial planner who helps retired clients ease into a decumulation mindset – spending their hard-earned wealth to put more life in their remaining years – Chapman says annuities are an essential piece of a well-built retirement spending strategy. With fewer guaranteed income sources like defined benefit pensions to rely on, he says longevity risk is weighing on retirees’ minds more than ever before.
“Retirees won't spend money today if they believe they might need it tomorrow,” he says. “Studies have shown a dramatic increase in spending for those who incorporate buying income they can never outlive as part of their retirement plan, with many retirees spending twice as much each year as a result.”
In its launch statement and marketing materials, Desjardins touted ALDAs as a tax-efficient product, as using them would help reduce the tax bite from retirement account withdrawals past a retiree’s 71st birthday. But Chapman argues that benefit only makes sense for a small group of wealthier retirees.
“Even then, the pitch of using an ALDA for tax savings is a slippery slope. Most retirees don't know their tax situation when they're 85,” he says. “When the ALDA begins, if they're the sole survivor and can no longer split income with their spouse, they might inadvertently defer income into a substantially higher tax bracket, potentially negating any short-term tax savings.”
Planning applications for ALDAs
Chapman sees other effective planning use cases for ALDAs. Many retirees thinking of long-term care, he says, plan to pay for it by selling their home: the cash windfall from the sale, along with cash flow freed up from not having ongoing home maintenance expenses, can go towards the costs of residing in a long-term care facility moving forward.
Retirees who don’t have that option, he says, could buy an ALDA to set up an income stream in advance that would support those later life expenses, giving them the confidence to spend more today.
“The issue there is that you’d be locking money away for a long time, to buy a solution for a problem you’re not sure is actually going to happen,” he says. “So this is something I would struggle with.”
Too many retirees, he adds, don’t have a competent or trustworthy financial power of attorneyv, which can be a real risk if – or when – they become unable to make financial decisions themselves. With an ALDA, Chapman argues retirees can help protect their income from potential poor decisions, or remove some of the financial decision-making burden from their designated POA.
But the real winning application of ALDAs, to Chapman’s mind, would be to complement other pensions and guaranteed income sources, especially for inflation protection.
“CPP and OAS, for most retirees, are the only sources of inflation-protected guaranteed income. Some retirees on DB pension plans enjoy inflation protection on that income, but not all,” he says. “They could choose to get an inflation-indexed annuity, but those can cost a small fortune.”
With ALDAs now on the menu, Chapman says retirees can now choose to self-insure against the ongoing impact of inflation by setting up an additional layer of income to kick in decades down the line.
“An ALDA would allow you to do some makeshift inflation indexing. You could go buy a standard annuity, and then use the ALDA to bump up or index an existing life annuity that you bought, or potentially an existing pension from a workplace that doesn't have indexing benefits,” he says. “Seeing that stepped-up income in their later decades could be valuable for retirees.”
Desjardins is offering its ALDAs as part of its lineup of responsible annuities, which means premium payments will automatically go into investments based on strict ESG criteria. That could make those investments more or less attractive, Chapman says, depending on the retiree and the advisor they work with.
“I'm a big tree-hugger, but I don't often recommend ESG investing to clients, usually because of the increased costs,” he says. “Instead, I think they should invest in a standard portfolio and spend the cost savings on local ESG initiatives. That way, they connect with their community and spend on their values rather than invest in them. … I’ve found that resonates with a lot more people.”
