As life expectancies have risen and interest rates have fallen, Canadians have become increasingly worried about outliving their money. The federal budget has introduced an interesting solution. It is one I wrote about in a December 2018 column aboutwhy retirement planning needs to be a major political issue in 2019 and beyond.
The proposed introduction of the Advanced Life Deferred Annuity (ALDA) is the biggest change in the Canadian retirement planning landscape in quite some time. The ability to defer Canada Pension Plan (CPP) or Old Age Security (OAS) to age 70 pales in comparison, and the introduction of Tax Free Savings Accounts (TFSAs) was meant for savers of all ages as opposed to just retirees.
Starting in 2020, an ALDA could be an investment option available to anyone with a Registered Retirement Savings Plan (RRSP), Registered Retirement Income Fund (RRIF), or similar registered plans like a Defined Contribution (DC) pension plan.
An ALDA would permit up to 25 per cent of an individual’s registered investment accounts to be used to purchase an annuity that begins payments at the latest by the end of the year that they turn 85. There would be a lifetime maximum of $150,000 that would be indexed to inflation and rounded to the nearest $10,000.
The most common registered plan decumulation solution currently is a RRIF, which holds investments and has minimum required percentage withdrawals that rise each year as you age. Investments can include cash, GICs, stocks, bonds, ETFs and mutual funds. Withdrawals are taxable, and an account becomes fully taxable to the owner upon their death unless left to a surviving spouse, common law partner, or financially dependent child or grandchild.
Annuities are also an option currently, whereby an RRSP holder exchanges a lump-sum of cash for a stream of ongoing monthly or annual payments from an insurance company. These payments can continue for the life of the purchaser, or for the joint lives of the purchaser and their spouse or common law partner. Some annuities have guarantee periods if the annuitant dies before a minimum number of years.
Annuities have been unpopular recently in part due to low interest rates that result in lower annuity payments. As a result, the annuity market in Canada is not as robust and efficient as it could be due to low demand.
ALDAs could change that and make annuities a more viable option from an investment, tax, and estate perspective for the right retirees. Who might that be?
Stocks are a great way to build wealth. There is risk inherent with investing in stocks, and with risk, comes reward over a long enough timeframe. A long-term investment strategy should ideally include stock exposure, but there are people who have no tolerance for risk. Conservative mutual funds may not be a great place for these people to invest, because the fees, particularly these days, do not leave much return left over. Annuities may be an investment solution for conservative retirees, including ALDAs starting in 2020.
Someone without a defined benefit (DB) pension plan to pay them a guaranteed monthly income could also be a potential candidate for an ALDA. ALDAs and other annuities act as an insurance policy against living too long, helping to mitigate longevity risk. Retirees with DB pensions already have an income stream that gets paid as long as they are alive, but those without pensions may benefit more so from considering an ALDA for their retirement savings.
There is an interesting tax reduction opportunity with an ALDA. Taking money from a registered account to put into an ALDA reduces minimum required RRIF withdrawals during your 70s and right up until age 85, when ALDA payments must begin. This can present a tax deferral opportunity for a retiree with a long life expectancy, a high tax rate in their 70s, or other retirement incomes sources like corporate assets or rental real estate they can access in the interim.
The income deferral of an ALDA may also make mandatory RRIF withdrawals at age 72 less taxing for those retirees who are still working into their 70s. ALDAs may also help reduce OAS clawback for high-income retirees.
It is important to point out that the tax deferral mechanism of an ALDA is an opportunity and not necessarily a benefit. As I have written about many times before, tax deferral at all costs is not always the best choice, and sometimes, less lifetime tax can be paid and a larger estate created by taking early RRSP/RRIF withdrawals.
Do-it-yourself investors may also be ALDA candidates. As people age, they can become less able to make complex financial decisions, and this is a real risk for DIY investors in their 60s and 70s. Moving RRSP/RRIF savings into an ALDA means less money to manage, and possibly less retirement income risk in the later years of retirement.
Financial advisors may be put into a difficult position with their clients, given an ALDA could diminish 25 per cent of the registered investment assets they manage for an investor. It will be incumbent on advisors to objectively evaluate the pros and cons of ALDAs once they become an option for retirees in 2020.
Retirees will also be put into a difficult position. Annuities and ALDAs both require an investor to hand over their hard-earned savings in exchange for a future income stream. It is amazing how many people fawn over defined benefit pension plans, but how few are willing to give up control of their money to purchase an annuity.
While I can appreciate many of the benefits of annuities and ALDAs myself, I also try to imagine handing over a quarter of my RRSP to an insurance company in 30 years when I am considering my own options. As someone who values flexibility and control of my own financial affairs, I can see how for some investors, no annuity may be enticing enough to become a viable option.
That is okay though. Stocks are not for everyone. ALDAs will not be either. The more options Canadian retirees have available to them the better as far as this financial planner is concerned, even if I never opt for an ALDA myself.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.