Are annuities a wise investment choice for retirement?

Michael Callahan, CFP®, CIM®

When it comes to financial planning and securing a stable retirement, annuities are often overlooked or misunderstood. Annuities, however, can play a vital role in ensuring you have a steady stream of income during your retirement years. In particular, annuities can provide a guaranteed income for life, making them an attractive option to create a stable retirement income and enhance your long-term financial security.

What are annuities?

Annuities work on a simple premise: you make a lump sum payment in return for a guaranteed, predictable, ongoing stream of payments. In this sense, annuities create a pension-like income that can be particularly attractive to retirees who need to convert a portion of their savings into a retirement income stream. The amount and duration of payments can vary as annuities can be structured to provide income for a specific period of time or for life.

Retirement risks and realities

Retirees today are facing two significant new realities. First, we are living longer than ever before. Indeed, life expectancy in Canada has increased by more than 20 years during the last century. That's very good news, but the flip side of that coin is we now face a much greater risk of outliving our savings – this is known as longevity risk.

Second, only about 1 in 3 Canadians has an employer pension.¹ We can no longer rely on employer pensions to provide for us when our working days are done. After saving and investing throughout our working years, we are the ones responsible for turning that pool of savings into a lifestyle-sustaining retirement income stream. Yet, market volatility and unpredictable investment returns can threaten an otherwise healthy retirement income. What can you do?

Top 3 benefits of annuities

Annuities offer a unique set of benefits to retirees, including:

1. Lifetime income: Annuities can provide a steady stream of income for life, eliminating the risk of outliving your savings and recreating some of the comfort that many people have with receiving guaranteed income. In this sense, purchasing an annuity can be thought of as buying yourself a guaranteed pension-like income. Indeed, with a life annuity, you can be sure to receive an income for the rest of your life.
2. Tax advantages: Certain types of annuities offer additional tax benefits and a tax-efficient source of retirement income. In particular, a special type of annuity known as a prescribed annuity can ensure that the taxable portion of your annuity payments is stable and predictable so you won't be caught off guard with any unexpected tax consequences.
3. Protection against market volatility: Annuities shield you from market fluctuations, providing financial stability during your retirement years. A key risk when drawing an income from your retirement savings is suffering poor market returns especially in the early years of retirement. Annuities can help shield you from this risk and potentially  protect your retirement income against market volatility.

Bottom line

While they may seem complex at first glance, annuities need not be a mystery. Rather, annuities are valuable tools that can provide financial security and peace of mind in retirement. Remember, it doesn't have to be an 'all or nothing' decision – you can use a portion of your savings to purchase an annuity while leaving a portion of your retirement assets invested elsewhere in financial markets. To find out more, speak with our Edward Jones advisor today.