Annuities are a blessing and a curse for couple whose income has dried up during pandemic

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Out of work, couple in early 60s are having to run down savings built over decades of work

In Alberta, a couple we’ll call Barry, 61, and Marissa, 63, are suffering from the virus-driven financial meltdown. Barry, formerly a contractor in the building industry, has been feeling the effects of corporate spending cutbacks. Business has dried up. Marissa, a clerk in office administration, recently lost her job. Their present combined income, less than $1,000 per month, does not cover allocations of $3,345 per month. They are running down financial assets of $871,650 built over decades of work. They worry that even with Old Age Security and Canada Pension Plan benefits they will be unable to maintain their modest standard of living. Their goal is $5,500 per month after-tax income in retirement.

Family Finance asked Eliott Einarson, a Winnipeg-based financial planner with Ottawa’s Exponent Investment Management Inc., to work with the couple.

Cash and future income

Barry and Marissa have $87,310 in cash and chequing accounts earning virtually nothing, $53,700 each in TFSAs invested in low interest GICs, $676,940 in RRSPs, a $300,000 home and an old car they think is worth $10,000. Add personal effects with an estimated value of $40,000 and their assets total $1.2 million.

They have a problem of their own making — actually the result of exceptional conservatism in structuring their retirement income. Most of their retirement income will come from life annuities that start when each is 65.

“They’ve locked themselves into life annuities with no downside and no upside either,” Einarson says.

With almost no present earned income, they have to tap savings not locked into those annuities.

Before Barry, two years younger than Marissa, is 65 and all retirement income is flowing, they could have $428 per month from RRSPs that are not tied up in annuities and $264 per month from their TFSA accounts. They would have no income tax to pay but the sum, $692 per month, will not sustain monthly allocations of $2,945 for basics excluding savings. They would need to add $2,253 from cash each month. Their chequing and savings balance, $87,310, would vanish by the time Barry would be 65, Einarson estimates. Any residue of what is not spent can be used to cover the widening gap between unindexed annuity income and the rising cost of living.

Assembling retirement income

Starting at 65, Marissa will have two streams of income: RRSPs and a TFSA.

Her RRSPs, which total $275,250, are themselves split into $163,400 in insurance annuities that will provide a lifetime taxable income of $730 per month or $8,760 per year, and non-annuity funds of $95,073. If the latter pool grows by three per cent for two years until she turns 65, she would have enough to generate $4,704 per year or $392 per month for 30 years to her age 95. She also has a TFSA with a present balance of $53,700 in GICs that can provide a return of $2,660 per year for 30 years.

Before age 65, those streams would combine to give her annual pre-tax income of $16,124. At 65, she could add OAS income of $7,362 per year and CPP income of $6,600 per year and her company pension of $5,050 per year for total income of $35,136 before tax.

Barry has RRSPs with $381,990 in life annuities that will provide a lifetime taxable income of $1,525 per month or $18,300 per year starting at age 65. His non-annuity RRSPs, $19,700 after adjustment for the ongoing market contraction, would with three per cent growth produce taxable income of $1,035 per year over the 30 years from his age 65 to 95. He would also have TFSA income based on a current $53,700 balance in GICs of $2,660 per year for 30 years to his age 95. He could add OAS of $7,362 per year and CPP payments of an estimated $13,260 per year. His age 65 income would therefore be $42,617.

Combining the couple’s income when Barry is 65, they would have $77,753 before tax. With TFSA income totaling $5,320 per year set aside, they would have $72,433 in taxable income. With splits of eligible income, age and pension credits, they would pay tax at an average rate of 12 per cent and with TFSA cash flow restored, they would have about $5,800 per month to spend. That exceeds their $5,500 retirement income target, and is more than enough to cover their monthly allocations, which would decline to $2,945 once $400 monthly TFSA savings are eliminated at Marissa’s age 65.

The annuity problem

There is an embedded problem in the ultra-safe structure of the couple’s retirement savings. Their life annuities are a bulletproof, contractual promise of income. In the very unlikely event that the insurance company running the annuities were to fail, the insurance industry backup fund, Assuris, would maintain their income. However, their annuities’ income will not be indexed to inflation and will therefore lose purchasing power over time.

Barry and Marissa could preserve some savings by starting CPP sooner than 65. They would pay a penalty of 7.2 per cent per year of the age 65 sums for each year prior to 65 they start benefits. That would give them more income sooner and less later. They would cure an early deficit only to have a potentially larger deficit in future.

A potential inheritance of $150,000, which could come soon or be many years distant, could help them weather the effect of lost purchasing power. If received starting at Marissa’s age 65 and used over 30 years, then ignoring growth, it could add $400 per month to their budget. However, we cannot time it, so it is not part of future income estimates.

If either or both partners find new work, their annuity income can be saved for rainy days. When the first partner dies, though the annuity income will continue to the death of the other, there will be a loss of one OAS payment, most of one CPP benefit and the ability to split incomes, Einarson notes.

“I think the survivor will get by, though with falling spending power as fixed annuity payments lag cost of living,” he says.

3 Retirement Stars *** out of 5