Should retirees in their early 70s partly annuitize?

Historically, Canadians have tended to avoid annuities, especially all those years when interest rates were so low. But now that rates are closer to 5% than to zero, annuities are being talked about again, especially by those nearing the RRIFing age. 

In our family’s case, this decision is still a year or two away (you can use your spouse’s age, which in my case means a one-year deferral of this decision). But, I did consult several experts as to whether they thought the case for annuities—or at least partial annuitization in parallel with setting up a RRIF—is stronger now.

Those who lack employer-sponsored defined benefit (DB) pension plans, and therefore have hefty RRSPs, are particularly good candidates for annuitization. Yes, it’s true that most Canadians will have some inflation-indexed annuities in the form of the Canada Pension Plan (CPP) and Old Age Security (OAS), but some may feel comfortable transferring a bit of stock market and interest rate risk from their own shoulders to those of the insurance companies that offer annuities. 

With respect to the interest rate hikes of the past year and what they mean for annuities, “I agree that the timing is ripe for those approaching retirement,” says Rona Birenbaum, founder of Toronto-based Caring for Clients, a financial planning firm that includes annuities in its offerings.

Birenbaum—who is working to help my own family take a partial plunge into annuitization—suggests looking first to non-registered money that could be earmarked for an annuity, as it’s very tax-efficient. Alternatively, “using RRSP assets makes sense, providing the lack of liquidity doesn’t constrain future needs.”

The case for gradual partial annuitization

Famed finance expert Moshe Milevsky, who has authored several books on retirement and annuities—notably Pensionize Your Nest Egg (Wiley, 2015), co-authored with Alexandra Macqueen—told me in an email for this column, “I will say that I have grown to become a fan of ‘slow partial’ as opposed to ‘rapid full’ annuitization, which helps smooth out the interest rate risk and is even more valuable from a behavioural psychological perspective.”

Milevsky explains how “slow partial annuitization” can work: You start out with a small monthly income, then continue to build it. “Perhaps in larger bursts when rates are higher—as they are now—and depending on how your finances and the market evolve, increase annuitization as you age.”

This isn’t just a gut feeling on Milevsky’s part. He adds: “There are a growing number of academics—mathematicians—who have ‘proven’ this is the optimal strategy. I wish insurance companies in Canada would make it much easier to buy [annuities] in small units, almost like a book of stamps at the post office.”

How much you “pensionize” will depend on pre-existing pension assets, such as DB pensions, CPP and OAS, as well as your health and needs for liquidity. That, Milevsky says, is why “retirement income” is such a difficult and challenging problem to solve. “But having at least a little bit of annuities is a no-brainer… which makes you look good and smart at the bridge club.”

Protracted inflation makes former annuity fan more cautious

Oddly, another retirement expert—Fred Vettese, author of The Essential Retirement Guide (Wiley, 2016) and other financial books—is somewhat less keen on annuities “now that interest rates are up” than he was when rates were closer to 2%. (Vettese has been a fan of annuities in the past.) The reason for the change of heart, Vettese says, is that “I had implicitly assumed that inflation was dead and we now know better.”

While inflation seems to be subsiding from the highs reached in 2022, “it seems almost inevitable [it] they will spike again, although the timing and the precise reason are unknowable at the present time.” Vettese suggests that for older retirees, aged 70 and higher, “there is still some reason to include annuities in one’s decumulation strategy, although I would limit any purchase to about 25% of one’s RRSP or RRIF.” 

While you might think inflation-indexed annuities would be the best of all worlds, Vettese says “the insurers were always reluctant to provide indexed annuities. Things likely haven’t changed. If they were available, the price would be prohibitive.”

Milevsky agrees these would be much better but are also more expensive: “After all, you are paying for an additional layer of insurance: price insurance and longevity insurance.” However, he adds, “I really don’t think every single dollar of income that a retiree receives in retirement must be inflation-adjusted—increasing every year by exactly the CPI. After all, CPP and OAS are inflation-adjusted automatically, and some expenses do decline or even disappear as you get older.” (CPI stands for the consumer price index.)

Also, Milevsky says, inflation hedging can take place with assets rather than income. “You can buy assets whose value keeps up with inflation, even if the income itself isn’t linked in a direct and transparent manner to an inflation index such as the CPI.”

Birenbaum suggests the portion of your RRIF that isn’t converted to annuities and is therefore still invested in securities (stocks, bonds, ETFs, etc.) should have some element of inflation hedging. 

As financial blogger Dale Roberts and others have blogged, this might include dividend-aristocrat stocks or exchange-traded funds (ETFs), where the underlying holdings regularly raise their dividends. It can also include: real asset funds, like Purpose’s Diversified Real Asset Fund (PRA); gold or precious metals bullion or stock funds; commodities; energy stocks; and similar plays. 

One financial planner and blogger was ahead of the curve on rates and annuities. A year ago, on his Boomer & Echo blog, Robb Engen made the case for annuities just as interest rates were starting to rise. See “Using Annuities to Create Your own Personal Pension in Retirement.” 

“Annuities fell out of favour (if they ever were in favour) when interest rates plummeted over the past 10-15 years. But with interest rates on the rise, annuities are certainly worth another look.”

Engen’s case for annuities revolves around how they minimize longevity risk: the fear many retirees have that they’ll outlive their money. He referenced Milevsky when he wrote: “It’s puzzling why more Canadians don’t choose to turn even a portion of their savings into an annuity—to pensionize their nest egg, to borrow a phrase coined by financial authors Moshe Milevsky and Alexandra Macqueen.”

Even a year ago, when he saw annuity quotes from RBC Insurance, Engen admitted that he “perked up when I saw the payout rates were between 5% and 7% of the initial deposit.” He included a table showing that a 65-year-old male investing $100,000 in an annuity would get an annual payment of $6,508, versus $7,310 at age 70, and a 65-year-old female would receive $5,411 annually versus $6,125 for a 70-year-old female.

However, a year later, I am surprised that annuity payouts don’t seem to have surged as much as you might think, given the interest rate increases of the past 12 months.

Fred Vettese says he has gotten “the same impression. I guess the insurance companies aren’t keen to commit to too high an interest rate over such a long term.”  Milevsky says annuity rates have increased in the last year but “remember that annuities are priced off the ‘long end’ of the yield curve, which hasn’t increased as much as the ‘short end.’ Even the Bank of Canada can’t control that…”

Birenbaum suggests, the lack of surge pricing “has to do with the other factors that drive pricing: mortality expectations vs. actual experience for the insured. There are few insurance companies offering annuities so limited competitive pressures.”

Prescribed annuities versus registered annuities

In my family’s case, Birenbaum suggests a non-registered prescribed annuity, which is far more (88% more!) tax-efficient than non-registered guaranteed investment certificates (GICs). 

Currently, each $100,000 of a prescribed annuity will yield $6,438 in annual income, with tax payable of only $750. Inside a RRIF, for a $100,000 deferred annuity with payments starting in January 2025, Birenbaum estimates monthly income would be $550.20 to $591.70, depending on the annuity provider. (Twenty-year guarantee and 100% continuance to the second spouse.) She also notes that Assuris (a nonprofit that protect policyholders of life insurance against insurance company failures) is raising the income guarantee on annuities from the current $2,000 per month to $5,000 per month. 

In short, since Ottawa insists that those in their early 70s must make decisions as to the fate of their RRSPs, we’ve opted to take an initial but gradual plunge into partial annuitization. If payouts start to catch up to rising interest rates, and as mortality credits rise as we age, we may consider adding more annuity tranches in later years.

More from Retired Money:

• The five factors of retirement for Canadians
• Should you cash out your workplace pension when you leave a job?
• How retired parents can use the FHSA to help their adult children
• Is now the time for retirees to sell stocks and buy GICs?

About Jonathan Chevreau

As MoneySense’s Investing-Editor-at-Large, he is also author of Findependence Day and co-author of Victory Lap Retirement. Reach him at [email protected], where he is the founder of Financial Independence Hub.

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