Last month we talked about falling meteorites – so I think it’s appropriate to talk about the extinction of the dinosaur this month!
If you’re a movie buff, you likely know that one of the summer’s hot movie tickets is yet another Jurassic Park movie, where extinct dinos are brought to life by crazy scientists. (You would think after five movies, they would realize you probably shouldn’t have brought dinos back to life, but who am I to judge?)
Events in the last few weeks have served a strong reminder that many things we take for granted in our financial life don’t have an unlimited lifespan – and that includes money for life in retirement.
The heart of many people’s retirement income is their pension. Like many of you, Jim has worked hard his whole life to earn that pension. Every paycheque, money goes into his pension, paid for by Jim and his employer. When he retires this fall, he’s looking forward to having 70% of his income replaced by his work pension, or so he thinks.
Life’s gonna be good! Or will it? Jim came to me to try and figure this out, as he had an offer to retire early, and wanted to figure out if it will be financially viable to retire early.
The fossilizing nest egg
Unfortunately, once we started looking at things, Jim’s pension started to look like a real velociraptor’s breakfast. Unlike in days of yore, Jim’s employer doesn’t have a defined benefit plan, which provides a fixed amount in retirement. In Jim’s case, his employer moved to a defined contribution plan, which works a lot like an RRSP – Jim chooses his investments from a selection of offerings, and he gets whatever the balance happens to be at retirement.
Jim’s retirement is depending on those funds – but hopefully there isn’t a market downturn over the next few months, or he might have to hold off a bit longer. We’ve encouraged him to move a chunk of his holdings to cash as retirement draws nearer while we sort out the long-term plan. We know his funds are sufficient right now to handle retirement – but they might not be if a market downturn happens. If Jim had a defined-benefit pension plan, this wouldn’t even be a concern to him.
Who wants a gold-plated pension plan? Jim does!
Let’s be honest – most of us would love a defined-benefit pension plan, but most employers no longer offer these plans as they have a potential negative effect on their bottom line if retired employees live a long lifespan. Fortunately for Jim, there is another option – buy an annuity.
An annuity is basically a “purchased” defined-benefit pension plan. You go to an insurer (or, sometimes for non-registered money, a charity that you want to also donate to) and give them a lump sum in return for guaranteed income for the rest of your life. Think of it as the inverse of life insurance.
A lot of people I talk to at first glance don’t like annuities – ironically though, most of them, when asked, wish they had a defined-benefit pension plan. For some reason, we have a hard time psychologically make the connection between the two, even though in many ways they are very similar in what they provide.
An extinction-level financial event happened last month.
On June 29, one of Canada’s largest insurers – Manulife – announced they were no longer going to sell fixed annuities. This may be one of the biggest shockwaves in the investment community in years. While many small insurers have removed certain product lines, up until this point, no major insurance company has removed annuities from their product offering. For consumers like Jim, this can only be seen as bad news going forward. Less competition usually leads to less favourable rates, and, potentially, if Manulife doesn’t see annuities as a viable business line, other major insurers could be looking at exiting the market as well.
Imagine a world where you can’t find a way to get income for life… It’s scaring Jim, and it’s scaring me a bit too as a planner. We use annuities and defined-benefit pensions to address longevity risk in retirement plans. In my experience, the greatest risk in retirement is not how much you earn – but how long your cash flow will last. Other than defined-benefit pensions and annuities, the options are few and far between, and usually much more expensive.
If, like Jim, you are retired, or retiring shortly, and don’t already have a fixed source of life-long income in your plans, I encourage you to review your financial plan to see if annuities are a useful tool – before they’re potentially a relic of the past.