There are many financial products available for retirement saving and retirement income, but only a few are specifically designed for clients looking to ensure they don’t outlive their savings.
Running out of money during retirement is a genuine concern, according to a report from Deloitte Canada, which found that Canadians aged 55 to 64 risk outliving their retirement savings.
One product type that can help reduce longevity risk is annuities, which have garnered renewed attention since interest rates began rising in recent years. These insurance contracts offer a guaranteed annual income, usually beginning at age 65, in return for a lump-sum or premium payments made prior to the benefit period.
Annuities aren’t new; enabling legislation for government annuities was enacted in 1908.
But for clients who fear outliving their savings later in their retirement, there’s a relatively new annuity on offer: the advanced life deferred annuity, or ALDA.
What is an ALDA?
ALDAs were introduced in the 2019 federal budget; relevant legislation was passed in 2021. Clients can transfer into an ALDA up to 25% of one of the following qualified registered retirement plans, to a prescribed limit ($170,000 for 2024):
- RRSP
- RRIF
- deferred profit-sharing plan
- pooled registered pension plan
- money-purchase pension plan
The annuity payment can be delayed until the year the client turns 85.
If a client overcontributes, they may be subject to a 1%-per-month penalty on the excess.
“It’s the type of longevity product that I love the idea of because it deals specifically with tail risk,” said Jason Pereira, senior partner with Woodgate Financial Inc. in Toronto. Pereira recently quoted an ALDA for a client.
Who benefits most from ALDAs?
All annuities provide fixed income, but ALDAs specifically provide income much later in retirement. People who have a family history of long life expectancies, are in good health or have other sources of income early in retirement might consider ALDAs as a source of income later in retirement.
Understanding life expectancy is key to determining whether a client would benefit from an ALDA, said Pereira, who recommends referring to a probability-of-survival chart. Many people misunderstand life expectancy, which is often regarded as a terminal date. They often underestimate their chances of living into their 90s.
“A 55-year-old male has a 25% probability of living to 94,” Pereira said. “So, even though the life expectancy for the general population is closer to 85, you still have a 25% chance of making your 90s.”
Key features of an ALDA
The money used to buy an ALDA is tax-deferred until withdrawn, when it becomes taxable. The income generated by an ALDA continues for your client’s lifetime. The guaranteed income can mitigate economic uncertainties associated with fluctuating interest rates and markets.
ALDAs aren’t added to a RRIF balance for purposes of calculating a client’s annual RRIF minimum withdrawal. Because only the RRIF amount is subject to a minimum withdrawal, chances are lower that old age security and the guaranteed income supplement will be clawed back.
If the annuitant dies before the first ALDA payment, the full purchase price is returned to the beneficiary. If death occurs after the first payment, the beneficiary receives the difference between the purchase price and the payments already made.
A female client who makes the maximum ALDA contribution of $170,000 in 2024 at age 55, deferring to age 85, would have a gross payout of $96,500 a year, based on an illustration from Desjardins Insurance. So, the client would recoup their original purchase amount within two years of turning 85.
Interest rates significantly affect the purchase of annuities. Moshe Milevsky, a professor of finance with the Schulich School of Business at York University in Toronto, said clients must understand that from an interest rate perspective, “these are very similar to long-term and non-traded bonds with an extra longevity credit kicker.”
Milevsky warned, however, that if interest rates continue to rise as they have in the past few years, a client who purchases an ALDA could regret doing so.
Pereira said he understands the mindset to always want a better deal. But clients buy an ALDA because they have a demonstrable need, based on a plan showing longevity risk, he said. “The sooner you buy, the sooner you have greater certainty,” he said.
Pereira added that the ALDA is a carbon copy of the qualified longevity annuity contract available in the U.S.
Right now, Desjardins is the only financial institution in Canada that offers ALDAs.
“If Desjardins is successful — if they attract attention and generate sales — then other insurance companies will jump in with similar products very quickly or emphasize their own competing products,” Milevsky said.
“This is a pure product that is about ‘what happens if I live too long?’” Pereira said. “People trade a portion of their RRSP for an annual payment. Once they get past a certain age, those payments will get pretty substantial and kick in exactly when the longevity risk kicks in.”
This article appears in the May issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.