When inflation is in the news there is increased focus on guaranteed interest type products, namely, annuities. But what exactly is an annuity and how does it work?
An annuity offers your client, the investor, an opportunity to relinquish a lump sum of money in exchange for a guaranteed periodic level cash flow. The periodic amount your client receives is based on their age, gender and prevailing market rates. There are two main types of annuities: a “term certain annuity”, where a period of time is specified for the cash flow and a “lifetime annuity” where the cash flow is guaranteed for life. In either case, the market risk is taken out of the equation as the cash flow is guaranteed for the pre-determined amount of time. Here are a few more factors to consider with your client:
The Risk Averse Investor
A risk averse client entering their retirement years might buy an annuity in their Retirement Income Fund (RIF) which will ensure that they receive a guaranteed amount during their retirement years. While this amount may not be as high as it could be if the client were to take on some risk, the amount is guaranteed and can offer the peace of mind that comes with guaranteed cash flow.
Annuity Settlement Option
When the annuitants to a segregated-fund contract pass away, the assets will flow to their beneficiary. In some cases, there may be concern about whether the beneficiary can manage a large lump sum of cash. In these instances, the annuity settlement option can make sure that once the annuitants pass away, the beneficiary will receive level, periodic cash flow on a monthly/quarterly/yearly basis for a certain term or for the remainder of their life.
A Hybrid Approach
A long-time employee of a company will often receive a defined benefit or defined contribution pension plan as part of their benefits. When an employee leaves their place of work, they are typically offered a few options regarding what to do with their pension. The first option is to commute the pension to a Locked-in Retirement Account (LIRA), construct a portfolio and take on some risk; drawing income as needed so long as the yearly income amount exceeds the client’s RIF minimum. The second option involves leaving the pension as is and taking the income outlined in the client’s pension documents. Lastly, the client may be able to receive the same cash flow as outlined in their pension but do so using a smaller capital requirement resulting in a lump sum returned to the client – a hybrid strategy. For this latter option, your client would provide their documents to an insurance carrier and the carrier would run a proposal to mimic the cash flow but do so with a smaller capital investment. Whether or not an insurance carrier can offer a superior pension is contingent upon a host of factors, which we encourage you to discuss with your local PPI Wealth Team.
Guaranteed Lifetime Withdrawal Benefit
Some carriers offer a “Guaranteed Lifetime Withdrawal Benefit” (GLWB) segregated fund contract; this product tends to be popular when interest rates are high. A GLWB can be thought of as a hybrid between a segregated fund and an annuity. The client will deposit a lump sum and be guaranteed a cash flow for the remainder of their life, but this cash flow will be generated from a diversified portfolio in a segregated fund wrapper. This type of solution offers all the benefits of a segregated fund like creditor protection, named beneficiaries on unregistered accounts, death and maturity benefits, etc., and also provides guaranteed cash flow like an annuity. Additionally, there are oftentimes provisions in the contract that increase the amount paid to the client as they age and income can be forgone in a given year to increase the income in subsequent years.
Definitely a few options to consider when it comes to annuities. In a higher interest rate environment, annuities and their variations certainly have their advantages and can be viewed as another option available to your clients and their loved ones.
For a similar article, read and share the client-friendly version of Inflation, Interest Rates and Your Client’s Investments. And if you have any questions about any of the topics discussed, contact your local PPI Collaboration Centre.
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Securing Guaranteed Interest Rates with Annuities