With pensions, particularly defined benefit pensions plans, becoming less common for many Canadians, Moshe Milevsky, associate professor, York University, sees an increasing need for annuities to be included as part of a retirement plan.
“In the old days, when people retired with a pension, this would not be an issue,” said Milevsky, speaking at a CFA Society event in Toronto on Monday. “Part of this is being driven by the fact that it’s more and more difficult to offer and find good pensions.”
Milevsky offered the following five tips to find out whether a client is a candidate for an annuity and how much of his or her portfolio should be allocated towards an annuity:
> Watch out for fees
Pay close attention to the cost of the annuity product, says Milevsky, as a high managing expense ratio will likely eliminate any gains from an annuity before a certain age.
“The most important determinant of optimal allocation is fees and product selection,” he says.
> Consider pension income
Take the client’s current level of pension income into account when calculating the optimal annuity allocation for his or her retirement portfolio.
“If someone has a really good defined benefit pension from work and his or her spouse has a really good defined benefit pension — she’s a teacher, he’s a government employee,” says Milevsky, “they’re not a candidate for a pension annuity product.”
> Discuss longevity risk
Get a sense of the client’s fears of living longer than their money can last.
Clients who fear outliving their money are longevity risk averse, says Milevsky, and are likely to want an annuity in their retirement portfolio.
> Interest rates
Pay attention to interest rates to get a sense of whether you should buy an annuity for clients now or later.
If you do projections around interest rates that lead you to believe that annuity prices are going to go higher, says Milevsky, you may want to hold off on purchasing such a product for a client.
However, there always the risk that your projections are not foolproof. “In any such decision there’s a risk that you could be wrong,” he says, “so maybe you want to hedge by buying a little bit now.”
> Ask about their kids
Talk to clients about whether their priority is to make their money last for them or if leaving a legacy to their families is more important.
Clients who put a strong priority on leaving an inheritance for their children, says Milevsky, should have a smaller portion of their portfolios allocated to annuities.