Retirement Schemes: Annuities, RRIFs, and Home Equity

Cat And Mouse Games

The schemes described in this story may seem far-fetched but they are actually very common. The most popular one is called an annuity.

Annuity

Simply put, an annuity is a contract between you and a financial institution (usually, but not always, a life insurance company). The issuer accepts and invests funds you provide them and then pays out a fixed stream of payments to the individual. You can purchase the annuity immediately when you retire, or you could invest in the annuity for years (the accumulation phase) before the monthly payments begin (the annuitization phase).

The main advantage to an annuity is the fact that you’ll never outlive your money. That monthly payment continues until you die. The disadvantages are the loss of control of your money and the possibility of leaving any inheritance. Once you sign an annuity, the issuer takes control of your funds and makes all the investment decisions. Similarly, whatever is left when you die is kept by the issuer.

As usual, a suspicion of guarantees is well justified. This guarantee does come at a price. Many seniors consider an inheritance to be a non-negotiable rite of passage. Of course, if you don’t feel the same way about an inheritance, an annuity could make sense.

If you think you may outlive your money the guarantee is enticing. You can’t know this for sure, but good health and a family history of longevity are good indicators. Remember also, the monthly payment will likely be fixed, meaning inflation will reduce your spending power over time.

Possibly the greatest advantage to annuities is their ease of use. There are no investment decisions, worries about market returns, cycles, or anxiety. It’s an easy way out of the burden of financial management. You simply sit back and get your monthly payment.

Naturally it’s a statistical risk for the annuity issuer. But they are experts at assessing that risk. They’ll make an educated guess as to your life expectancy and add an extra cushion to reduce their risk. They also have a very good idea what return they’ll make investing your money and how many years it’ll take before the payouts end up exceeding their break-even point. Obviously the payout amount will reflect the time period to break-even.

They are the cat and you are the mouse. Their objective is to get you to die before the average age, so they pay out less than they earn on your money. As the mouse, your objective is to live much longer than the statistical average, so you get the best value from this deal.

It sounds cruel but basically this is a deal based on the date of your death. The issuers win more often than they lose on these deals, which is the basis of their business plan.

Government Plan

The government is in on these types of deals as well. On the day you reach the age of 72, all your RRSP money must be converted into a Registered Retirement Income Fund (RRIF). Simply put, your funds are placed on a rigid schedule of yearly withdrawals at rates set by the government.

You must withdraw a fixed percentage of your savings every year starting at age 72 (5.28%) with the rate increasing yearly to age 95 and above (20.00%). These forced withdrawals can cause a senior to outlive their money, and give them more income than they want. This can cause claw backs to government assistance programs such as Old Age Security (OAS) and the Guaranteed Income Supplement (GIS).

You didn’t think you could shelter your money from taxes forever, did you? You are the mouse, and the cat wants his share of income tax on the money you’ve sheltered for years.

Reverse Mortgage

The last scheme I want to discuss are reverse mortgages. These have been around for a long time and are all based on the desire for seniors to own their home forever.

Unfortunately, many people can’t fund their retirement because they are house rich and money poor. The reverse mortgage allows you to unlock the value in your home as cash. The catch is that you can’t sell your house and when you die your house belongs to the issuer.

Note: As with all mortgages, a reverse mortgage will pay you less than the current sale value of your home. As an example, if you were 65 years of age, and lived in a $400,000 condo in Thunder Bay, you would get a mortgage for about $87,500.

Just as in the case of annuities, reverse mortgages are based on valuations and statistics. The market value of your home, appreciation, and the home owner’s ages will determine the cash value you will qualify for. They accept the risk that they’ll recoup their payout plus a profit when they eventually sell your home. If you simply can’t let go of your home for sentimental reasons it might be your only option.

I’m not a fan of any of these schemes for several reasons. They all take control away from me and ask for more than I’m willing to give. And to be blunt, they feel like “hurry up and die” offers. The advantages they offer simply come at too high a price for me to accept. Whether it concerns taxes, my home, or an inheritance, any offer that stands to profit from my early death makes me feel uncomfortable.

In a Nutshell

Let’s review: You are guaranteed a monthly payment for life, but the annuity issuer expects you to die early and takes away your inheritance. You essentially sell your home at a heavily discounted price, but are allowed to live in it. The issuer eventually gets years of appreciation from the sale of the home. You are allowed to shelter taxes (RRSP) until you turn age 72. After that, you’re forced into a rigid schedule of withdrawals (RRIF), the possibility of government benefit claw backs, and the payment of higher taxes.

If you choose to use these schemes, or in the case of a RRIF, are forced into them, always remember one point. You’re giving up more than you are getting. Only you can decide what you’re willing to give up, and that’s the price of the convenience these offers provide. As the mouse in a cat and mouse game, your adversary will always be much more powerful than you.

Rather have a plan that you control? Check out Retirement Money Mastery for some suggestions for retirement planning.

In my E-books (“Water Barrel” and “The Balance”) I discuss simple methods to live sensibly for today, take charge of your financial affairs, and invest safely for the long term. For more information please visit David Penna Amazon.

As always, I am not a qualified financial advisor. I just relate financial management to my own experience which may not resemble yours at all. Advice is frequently worth exactly what you paid for it. Most of mine came from expensive experiences.