Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a beginning or experienced investor, these weekly updates are designed to give you specific investment advice, including ways in which you can maximize your retirement income. Each Investor Toolkit update gives you a fundamental piece of investing strategy, and shows you how you can put it into practice right away.
Today’s tip: “It’s important to understand the limits of annuities if you plan to incorporate them into your retirement income.”
Annuities have some attractive qualities. But they also have several rigid terms that may not work in your favour.
The main benefit of annuities is that they offer stable, predictable income. That may make them suitable for part of your assets, depending on your age and investment experience. The main drawback is that annuity payments stop when you die. Although there are some cases in which this is not so.
There are basically three different kinds of annuities:
Term-certain annuities are payable to you, or your estate, for a fixed number of years. Your estate will receive the payments even if you die. You could outlive this type of annuity.
Single-life annuities are payable to you for as long as you are alive. These annuities may come with a minimum number of years of payments. If you die while the minimum payment period is still underway, future payments would go to your estate.
Joint and last survivor life annuities are payable as long as you, or your spouse, are alive.
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Three ways annuities can depress your retirement income
Stable, predictable income for retirement is obviously a big plus for any investor. But annuities do have certain disadvantages that could depress that income. Here are three drawbacks you should consider before you buy an annuity:
Link to interest rates makes today a poor time to buy annuities: The rate of return you receive on an annuity is linked to interest rates at the time you buy it. That makes periods of low interest rates, like today, an especially poor time for buying annuities. However, if you want to buy annuities, you could buy one annuity a year for the next five years. That way, your returns will increase if interest rates rise, as we expect.
It may be hard to get out if you change your mind: Unlike stocks, it can be difficult or impossible to sell an annuity if you decide it no longer meets your needs. Moreover, you will likely get a low price for your annuity because the date of your death is uncertain.
Tax treatment: When you own an annuity, the income payments you receive are made up of interest and a return of your principal. The return of your principal is tax free, but the interest portion of the payment is taxed as ordinary income.
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Ordinary income is taxed at a higher rate than returns on a stock portfolio. If you build your portfolio as we recommend, part of your return would come in the form of dividends from Canadian stocks, which qualify for the dividend tax credit. The remainder would come in the form of capital gains, which are taxed at half the rate of ordinary income, and are only taxed in the year you sell.
To maximize your retirement income, make sure you have a safety-conscious investment portfolio
In the end, we think most investors would be better off building a portfolio that contains the kind of high-quality investments we recommend our newsletters, well balanced across the five main sectors of the economy (Manufacturing & Industry, Resources & Commodities, the Consumer sector, Finance and Utilities).
At the moment, we advise against buying annuities or long-term bonds. However, our view may change along with interest rates and inflation.
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