RRSP-Annuities-Pensions

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Three areas that may end up being important for your retirement income cash flow include your RRSP, annuities and pensions (government and/or private).  You may have significant non-registered assets which make these forms of income less important but all individuals should have an understanding of how these form of income work and how they may complement your income from your portfolio.

The following provides a look at these three potential areas of retirement income:

Annuities

One of the challenges for investors entering their retirement years is how to efficiently turn their retirement savings into a steady stream of income sufficient enough to live off of for their remained of their lives.  Annuities can help here.

Simply put, by purchasing an annuity you are handing over a large lump sum of money to an insurance company, and in return they commit to paying you, with interest, in the form off fixed monthly, quarterly, or annual payments for the rest of your life. Like any good portfolio it is essential to have some diversity, and annuities should not make up the entirety of your retirement income stream, but are often under-utilized by Canadian investors. It is important to have a mix of investment assets that best suit your own goals and risk tolerance. Every ones situation is unique.

In order to determine how much of your nest egg you should put into an annuity, it is important to determine, as best you can, what kind of income stream you will require to comfortably live out your retirement years. Although this “budgeting for the future” may not be the most exciting task, it is extremely important in the planning process. Once you have a good idea of how much income you will need to live off of in your retirement years, it is time to examine your portfolio. How much of your investments are held in stocks? mutual funds? bonds? precious metals? Is there a gap between how much you will need, and how much income your current strategy will supply. If you find your strategy is coming up short, or you are looking to increase your comfort level in a relatively simply way, it may be beneficial to move some assets into an annuity, possibly even an insured annuity where there is an insurance policy that guarantees your capital being paid out upon your death.

It is critical to ensure that the provider of your annuity is financially strong.  One can look at their independent ratings through such firms as S&P, Moody’s or DBRS.   It is not only important to deal with an A company at a minimum (preferably AA or better) but also look at the trend of their rating over the last couple of years….are the ratings staying the same, improving or deteriorating. You want to do the best you can to ensure that your annuity provider is around for the rest of your life and that you are not risking your capital.

A quick look at an insured annuity? An insured annuity is a combination of a prescribed life annuity, and a life insurance policy. Purchasing an annuity can be beneficial because of the fact that cash-flow is derived from the principle of the annuity, which is non-taxable, and the interest payments from the annuity, which is taxable, but at a rate lower than the interest of a GIC is taxed at.  Not only are interest on payments taxed at a lower rates than GICs, but if you support your annuity by purchasing a term-100 life insurance policy, you can guarantee the return of your principle investment upon your death to your beneficiaries. It is also important to distinguish that annuities are not guaranteed by the CDIC, but rather are guaranteed by a government-regulated entity called Assuris, and is something to take into consideration, when determining your risk appetite, and strategy.

Why Use Annuities? Aside from the lower rate of tax that annuity interest incurs compared to GICs, annuities are a good way of providing conservative portfolios with more after-tax income, without increasing the overall risk of the portfolio.  This type of investing is generally used by older investors, looking to manage their retirement income, but it is important to note that, in order to qualify you must be in good health, and pass a basic physical examination. This strategy requires some advanced planning, and is not something you can rely on should you run into health problems later in life.

Registered Savings Plans (RRSPs, RRIFs)

A Registered Retirement Savings Plan (RRSP) is a savings or investment account, which is used to defer taxation on funds deposited within the account. The amount that is contributed to your RRSP will be deducted from the total amount of taxable income you earn for that year. So as an example, if you made $100,000 in 2012, and decided to contribute $10,000 to your RRSP, your 2013 earnings will only be taxed at $90,000.  Money earned from investments held in these accounts is allowed to grow tax free, until the funds are withdraw, at which time they are subject to taxation. For the most part, dividend income is not taxed, but the government does regulate which investments are permitted to be tax free within an RRSP, so it is important to discuss your holdings with a tax professional to ensure that you are minimizing your taxes payable.

Contributions to an RRSP are capped at approximately 18% of income earned during the previous year, up to a maximum amount as outlined by the government. This maximum contribution limit is to prevent unfair contribution by the ultra-high income earners of the country, who make significantly more than the average Canadian. In 2013, the maximum contribution to an RRSP was $23,820.  It is also important to not that like a TFSA, any contribution room unused is carried over to the next year, so it’s never too late to plan your retirement in a more tax efficiently.  Contributions into RRSPs can be made up until the age of 71, at which point you are no longer permitted to contribute. The same consideration can be said for spousal RRSP accounts, with contributions ending once your partner turns 71 years old.

It is also important to note that each year all contributions must be made 60 days following year-end, which generally results in a March 1 deadline, except during leap years. Should you miss the contribution deadline, you will be able to carry over the contribution allowance into the next fiscal year.

RRIF: A Registered Retirement Income Fund is the final road for an RRSP. Once age 71 is reached and the individual can no longer contribute to their RRSP, it becomes an RRIF that pays out a monthly income.

Pensions

Canada Pension Plan (CPP):  Almost all individuals who work in Canada contribute to the Canada Pension Plan (CPP). The CPP provides pensions and benefits when contributors retire, become disabled, or die.  Here are a few of the key attributes:

  • Retirement pension
    You can apply for and receive a full CPP retirement pension at age 65 or receive it as early as age 60 with a reduction, or as late as age 70 with an increase.
  • Post-retirement benefit
    If you continue to work while receiving your CPP retirement pension, your CPP contributions will go toward post-retirement benefits, which will increase your retirement income.
  • Disability benefits
    If you become severely disabled to the extent that you cannot work at any job on a regular basis, you and your children may receive a monthly benefit.
  • Survivor benefits
    When you die, CPP survivor benefits may be paid to your estate, surviving spouse or common-law partner and children.
  • Pension sharing
    Married or common-law couples in an ongoing relationship may voluntarily share their CPP retirement pensions.
  • Credit splitting for divorced or separated couples
    The CPP contributions you and your spouse or common-law partner made during the time you lived together can be equally divided after a divorce or separation.

Old Age Security Pension (OAS):   The Old Age Security (OAS) pension is a monthly payment available to most people 65 years of age and older who meet the Canadian legal status and residence requirements.  Your employment history is not a factor in determining eligibility: you can receive the OAS pension even if you have never worked or are still working.

Private Pensions:    Company pension plans are considered one of the three pillars of retirement planning, together with government pensions and personal savings. Understanding what to expect from a company pension is essential to effective retirement planning.  The two types are 1. Defined Benefit pension plan (DB Plan) offers an employee the security of knowing what to expect at retirement.  2.  Defined Contribution Plan offers an employee more choice and flexibility in their investment than a DB Plan. This allows a knowledgeable investor to tailor the plan to suit their own investment goals and tolerance for risk.

According to 2008 figures from Statistics Canada1, only 38% of paid workers had a company-sponsored pension plan as part of their compensation. For those who are covered, the two main types of company pension are the Defined Benefit pension plan and the Defined Contribution pension plan.  Canada is seeing a striking discrepancy in pension benefits between public and private employees, a trend that threatens to create two classes of retirees, a new report argues.

Two-thirds of Canadians working in the private sector, or 80% of the country’s employees, do not have a company pension plan, according to a report by the Canadian Federation of Independent Business (CFIB), called Canada’s Two-tier Retirement. In contrast, 87% of public servants, who make up 20% of the country’s workforce, have a workplace pension plan, which, in most cases, guarantees the benefit no matter what.

To replace 70% of their working income in retirement, federal government employees currently contribute about 7% of their salary, the report shows. To achieve the same goal, private sector workers would have to contribute up to 21% of their income.  “Governments are doing a huge disservice to the majority of taxpayers by permitting these disparities to grow,” says Plamen Petkov, author of the report and the CFIB’s Ontario director. “It’s time they took action to address the unfair gap between public and private sector retirement benefits.”  The study also shows that the average public sector employee retires at 61, while a private sector worker retires at 63 and a business owner at 66.

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