Don’t be Seduced by Annuities

By Ryan Goldsman, CFP®, PAIP®

            Every now and then an investment product or strategy goes through a challenging period. In spite of going through a bad decade or two, annuities continue to trail the airline industry which has gone through a bad century!

            After falling out of favor due to lower interest rates (which started in the early part of 2009), annuities are experiencing a resurgence, but it was almost inevitable.

            The popularity of annuities is largely correlated with interest rates; the higher they are, the more annuities are sold, and the lower they are, well, then the number sold declines.

            For investors, the biggest challenge may come in the form of a relative comparison, which depending on the time period selected could make almost anything seem attractive. When considering interest rates over the past century (instead of the past decade), it’s clear that current rates are far below the long-term average, and yet most savers are happier than ever. Clearly rates are far higher today than they were over the past decade.

            But again, to what are we comparing the present?

            Since annuities are considered most often when one collapses their RSP into a RIF, usually between the ages of 65 and 71, the purchase of an annuity is often a long-term commitment and a major milestone. Apart from marriage and having a child, there are very few commitments that last for 20 years or more, that we’re locked into.

            Why would we want an additional long-term, binding commitment?

            What many Canadians fail to realize is the rates offered by annuities should not be compared to rates of a 5-year guaranteed investment certificate (GIC). Instead, individual investors need to consider how much more they need to be compensated for committing their capital for a much longer period of time. As an example, if a 5-year GIC offers 4%, then an annuity which is expected to last for a period of 20 years or more should require more than a 5% rate of return. After all, what happens if the buyer makes the wrong decision?

            At age 65 or 70, or even older, it’s highly unlikely that a retiree will want to return to work out of a need to do so. Instead, one’s golden years should be enjoyed as a result of having choices.

            Although rates seem high right now, investors should not forget the relative comparison, and who knows? Due to advances in artificial intelligence, we could always be on the cusp of a major productivity increase which would translate to higher interest rates. Don’t be seduced. Instead, each one of us may want to consider what it takes to be able to pivot on short notice, at least with a portion of our portfolios.