Taking a closer look at insured annuities

In last week’s column, I talked about annuities and the reason why many people should give them a second look now that interest rates have risen so much.

But for many considering an annuity as part of their retirement plan, the idea of “surrendering” their money and not having anything left to pass on to their children is a tough one to wrap their heads around.

One option to overcome the inability to leave money behind is the insured annuity strategy. This strategy combines the benefits of an annuity with the security of life insurance to provide retirees with a reliable income stream while also leaving money behind for their kids.

Here's how it works. Let’s assume that John is a 65-year-old widower who has $1.5 million saved for his retirement and he has 2 adult children. John really wants to enjoy his retirement and do a lot of travelling but also wants to ensure that he leaves some money behind for his two kids as a legacy from their late mother.

John decides that he’d really like to leave $500,000 to the kids and assumes he’ll just live off the other $1 million. Assuming he starts off with a four per cent withdrawal rate on his $1 million, he accepts that he will have to live off of $40,000 per year.

But then John’s financial planner suggests looking at an insured annuity strategy for the other $500,000 instead of leaving it in cash or a GIC. The $500,00 earmarked for the kids goes into a life annuity that pays John $35,000 per year (guaranteed for life). John also sets up a T100 permanent life insurance policy that is guaranteed to never expire or change rates as long as he makes the payments, and it costs him $13,600 per year for the premiums.

By then taking the premiums out of the annuity payments, John is left with an additional $21,400 per year on top of the $40,000 he’s drawing annually from his other portfolio, increasing his annual retirement income by over 50%. The annuity and insurance payments/costs are both guaranteed for life so there is no risk involved and John is assured he will pass the $500,000 sum on to his kids.

John may also elect to have indexing built into the annuity payment which would decrease the amount he receives at the start, but will keep up with inflation. Either option works.

While it sounds like a slam-dunk, there are, however, some potential drawbacks to the insured annuity strategy. One is that it requires the purchase of a life insurance policy, which can be expensive if your health is not good. The cost of the policy will depend on a variety of factors, including the retiree's age, health, and lifestyle habits.

Another potential drawback of the insured annuity strategy is that it can limit the retiree's flexibility and control over their assets. Once the annuity is purchased, the retiree is committed to receiving a fixed income stream for the rest of their life. This means that they may not have access to their funds in the event of an emergency or unexpected expense.

So, with that in mind, you typically don’t want to put all or the bulk of your assets into this one strategy.

Despite these potential drawbacks, the insured annuity strategy can be an effective way for Canadians to ensure a steady income stream in retirement while simultaneously ensuring you have money to leave behind if you so choose. However, it is important to carefully consider the costs and potential limitations of the strategy before making a decision to pursue it.

An insured annuity strategy is definitely not for everyone but instead is a good example of one of the many strategies that a certified financial planner might consider when building a custom retirement plan for you.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.