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CFP® Newsletter

According to Statistics Canada, Canadians who have retired (baby boomers) or are approaching retirement are now the fastest-growing demographic. In 2011, the baby boomers — those born between 1946 and 1964 — account for close to one-third of Canada’s 34.5 million population. Approximately 5 million Canadians, representing 14.4 % of our total population, are now in the 65-plus range, and this number is growing. The median age in Canada is close to age 40.

Retirement Risk Zone

Moshe Milevsky, a professor at the Schulich School of Business at York University, has described Canadian seniors who are within ten years of retiring or have retired within the last ten years as being in the “retirement risk zone”. The three main risks facing seniors in the retirement risk zone are longevity, inflation and market volatility.

The response of financial planners has been to assess the impact of these risks on their client’s financial plan. This helps financial planners predict the chances that a retirement plan will be successful. Adjustments may need to be made to the retirement plan to help the client reach his/her goals. The financial planner then creates product allocation strategies to maximize the likelihood of the plan being successful. Clients with a low to medium financial risk tolerance may want to consider annuities and/or segregated fund Guaranteed Minimum Withdrawal Benefits (GMWBs) in their product allocation strategy.

Let’s take a look at some of the more common forms of annuities and GMWBs available:

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1. Life insurance company annuities are attractive to the conservative investor who wants a guaranteed income flow for a specified period, or for life. There are possible features offered with life annuities, which include the following:

a. Straight single life annuity

  • Provides an income for the lifetime of the annuitant.
  • Once the annuitant dies, there are no further payments.
  • Pays the highest level of annual income, compared to (b) and (c) below.

b. Single life annuity with a guaranteed number of annual payments

  • This is like a single life annuity in that it provides an annuity income for the life of the annuitant.
  • A single life annuity with a guaranteed number of annual payments also provides a guaranteed period of benefit payments (e.g., 5, 10, 15 years).
  • If the annuitant dies within the guaranteed period, the balance of payments within the guaranteed period will be paid to the beneficiary.
  • Because there is a minimum guaranteed payment period, the benefit per $1,000 is less than the single life annuity, without the guaranteed number of payments feature.

c. Joint life and last survivor life annuity

  • This annuity provides an annuity income throughout the lives of usually two persons. When the first stated annuitant dies, payments continue to the surviving spouse, if the spouse is still alive. Sometimes these annuities are designed to offer a higher payout to the first stated annuitant while alive, but the annuity payout amount reduces for the surviving annuitant after the first annuitant’s death. This is referred to as a “Step Rated” joint life and last survivor life annuity.

2.  Term Certain Annuity, also referred to as an annuity certain or a fixed-term annuity.

  • Annuity benefits are paid for a specified term only (e.g., 5, 10, 15 years).
  • If the annuitant dies before the term is up, the balance of the payments within the term will be made to the annuitant’s beneficiary.
  • Once the term is up, no further income benefits will be paid.

3. Segregated Fund Guaranteed Minimum Withdrawal Benefit (GMWB), also known as an Individual Variable Insurance Contract (IVIC) GMWB

  • Unlike a regular segregated fund with a principal guarantee after a minimum 10 years, a segregated fund with a GMWB is a fund which focuses on generating income.
  • Investors who have low to medium risk tolerance may be attracted to GMWBs.
  • With a primary focus on generating income, the GMWB addresses the problem of outliving savings through one’s retirement, reduction of purchasing power due to inflation and the depletion of savings due to market volatility.
  • An investor is promised a minimum return (e.g., 5%) based on their original investment.
  • Since the segregated fund is invested in securities, there is an opportunity to participate in the profits of the market, but there is no downside to the guaranteed minimum income payments.
  • There is a reset option every few years (e.g., 3 years) on the annuitant’s birthday, which allows the annuitant to lock in a new base for the future income guarantee.
  • Depending on what option is selected, the income stream may continue for as long as the investor lives, even if the residual assets have been used up; or the plan may provide income until the annuitant’s original investment is repaid (e.g. up to 20 years at 5% per year).

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GMWB Plans and Estate Planning

  • These plans retain features of a life insurance policy which include the potential for creditor protection and the ability to bypass probate.
  • GMWB plans offer privacy when assets pass outside the will and are paid directly to the named beneficiary.

Effect of Withdrawals on the Death Benefit Guarantee

  • The death benefit is 100% of the deposit less “proportionate” withdrawals”.  Amount of reduction in death guarantee = 
  • The death benefit guarantee is calculated as per the following:
    • Guaranteed amount minus adjustments for withdrawals.

GMWB Example:

Janet makes a lump sum investment of $500,000 into a GMWB plan at age 59. The plan calls for a 60% equity / 40% fixed income asset allocation. Assume an annual accumulation bonus of 5% each year, based on the original investment until Janet is age 65. This equals $25,000 per year for Janet [$500,000 x 0.05].

During retirement, the GMWB plan provides a minimum guaranteed annual payment of 5% of the GWB. The GWB starts at $500,000 and increases by $25,000 per year until Janet retires at age 65.

Janet will begin to draw income from the plan at age 65. She will receive the Guaranteed Withdrawal Amount (GWA) of $31,250 at the end of each year ($625,000 x 0.05) for life.

Age Annual
Return
Fund Value
at Year-End
Accumulation
Bonus
GWB Following
Year GWA
59 Initial Investment $500,000   $500,000 $25,000
60 3% $515,000 $25,000 $525,000 $26,250
61 -8% $473,800 $25,000 $550,000 $27,500
62 -21% $374,302 $25,000 $575,000 $28,750
63 4% $389,274 $25,000 $600,000 $30,000
64 -33% $260,813 $25,000 $625,000 $31,250
65 11% $258,252   $625,000 $31,250
67 1% $229,584   $625,000 $31,250
68 -17% $159,305   $625,000 $31,250

 

GMWB’s Terminology

Note: Terminology varies between product suppliers. Advisors should review the specific terminology as provided by the providers.

  • GWB: Guaranteed Withdrawal Base. This is the notional account within the GMWB plan, sometimes termed a bonus base, which is used to calculate the guaranteed annual income stream or Guaranteed Withdrawal Amount (GWA).
  • GWA: Guaranteed Withdrawal Amount. This is an annual payment calculated as a percentage of the GWB adjusted base amount. Some plans distinguish between allowed withdrawals before or after a certain age. Withdrawals up to this age are termed as a Maximum Withdrawal Allowance (MWA) while withdrawals taken afterward may be referred to as a Lifetime Withdrawal Allowance (LWA).
  • Automatic Income Guarantee Resets: Some providers automatically compare the GWB to the current market value of the plan at periodic intervals. If the market value exceeds the GWB, the GWB is increased to match the market value.
  • MWA: Maximum Withdrawal Allowance or Maximum Withdrawal Amount
  • LWA: Lifetime Withdrawal Allowance or Lifetime Withdrawal Amount

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Questions

Please answer the following questions about retirement income products. Answers and rationales to these questions will be provided in the December e-newsletter.

1. A non-registered straight life annuity protects the investor against what type of risk?

  1. The risk of dying too soon
  2. Inflation risk
  3. Longevity risk
  4. b and c

2. Which of the following annuities would provide the highest level of annual income? Assume that the same amount of premium was invested at the same time with the same insurance company.

  • Straight life annuity, male age 50, payable monthly, in advance
  • Straight life annuity, male age 60, payable annually, in arrears
  • Straight life annuity, female, age 50, payable monthly, in advance
  • Straight life annuity, male, age 60, payable monthly, in arrears

3. Which factors are used to determine the amount of annuity payments under a term certain annuity?

  1. Interest rates at the time of purchase
  2. The term of the annuity
  3. The frequency of the annuity payments
  4. The life expectancy and gender of the annuitant
  1. ii, iii, iv
  2. i, ii, iii
  3. i, iii
  4. i, iii, iv

4. What is true about GMWBs?

  1. The premium is invested in units of a non-segregated fund.
  2. The GWA or LWA varies with the consumer price index (CPI).
  3. The life expectancy of the annuitant (s) is unknown.
  4. The guarantee period under the contract is variable, at the policy owner’s discretion.

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Good luck with your studies!

Sincerely,

Ron Foran, CFP, CFA, CLU, FCSI
President, Foran Financial Institute

Ron Foran is the founder of Foran Financial Institute. He has lectured extensively around the world over 24 years on investments and financial planning. Ron has a passion for teaching, training and assisting students to pass exams, and is the primary instructor for Foran securities and investment management seminars. If you want to learn more about Ron or Foran Financial Institute, please go to www.foranfinancial.com.


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