A new tool could soon be available to ease your senior clients’ biggest financial fear—outliving their money.
That fear, along with not being able to pay for long-term care, was the most cited (25%) in a 2018 Leger poll. Anxiety about going broke could be particularly acute in this low interest rate environment, and for seniors with few guaranteed income sources and a family history of longevity. To help manage those risks, the federal government introduced the advanced life deferred annuity (ALDA) in the 2019 federal budget.
ALDAs would apply after 2020 and be purchased under certain registered plans, with guaranteed payments deferred until up to age 85—a substantial jump from age 71, when annuities purchased with registered funds generally begin. A purchase cap was set at 25% of the source plan, to a maximum of $150,000 (see “ALDA characteristics,” below).
Ron Sanderson, director of policyholder taxation and pensions at the Canadian Life and Health Insurance Association (CLHIA) in Toronto, says clients with long life expectancies should be informed about the ALDA as a tool aimed at providing lifelong guaranteed income. In particular, the ALDA could improve quality of life for those clients prone to reducing their standard of living out of concern for longevity, he says.
Sanderson also sees the ALDA as a way to prepare for capacity issues. As advisors and clients assess longevity risk and the potential for diminishing mental capacity, assets might be structured so clients don’t have to make financial decisions—especially if the client has no substitute decision maker.
“Annuities are a logical part of such plans, and the ALDA may have a role to play in such arrangements, particularly as life expectancy increases,” Sanderson says.
Moshe Milevsky, a finance professor at the Schulich School of Business at York University in Toronto, coined the term “ALDA” more than a decade ago. He says the product proposal presents opportunities for Canadians and advisors. An ALDA has been available in the U.S. since 2014 and is even more attractive for Canadians, he says, who are subject to certain clawbacks and higher marginal tax rates.
For example, based on income, Canadians can experience Old Age Security and Guaranteed Income Supplement clawback when they begin to withdraw from Registered Retirement Income Funds (RRIFs) at age 71. Clawback is a common client concern, considering 73% of seniors with government income also receive income from investments or company pensions, according to the Leger poll. ALDAs wouldn’t be included in RRIF minimum withdrawal calculations, so would help reduce clawback or delay it for up to 14 years, lessening a client’s marginal tax during that period.
Milevsky hopes the ALDA will “open the window of discussion” on annuities. While the typical annuity purchaser today is in their late 60s, he says, the ALDA potentially opens up the market to “Canadians who would never have dreamt of buying one because they always associate annuity with immediate income” when they convert their RRSPs.
Planning with ALDAs
In addition to helping manage tax and longevity risk, ALDAs would help clients the way all annuities do, says John Waters, director of tax consulting services at BMO Wealth Planning and Advisory Services in Toronto. The products provide a steady income stream for clients with few income sources and low risk tolerance who aren’t concerned about the associated loss of financial control or flexibility, including leaving a legacy, he says.
Clients who might otherwise leave the remainder of a RRIF to a beneficiary will have a smaller estate after purchasing an annuity, so they may want to consider alternative sources for such a bequest, Sanderson says.
As with all annuities, pricing factors include age and interest rates. While today’s persistent low rates make annuities less attractive because there’s less guaranteed income, delaying an annuity purchase means a client doesn’t take full advantage of the long internal investment return, Sanderson says. He suggests purchasing annuities at intervals over time to capitalize on the best rates and to manage other pricing factors.
Advisors can help clients understand annuities and ALDAs by likening them to a bond “supercharged with mortality,” providing income for life, as opposed to a bond that matures, Milevsky says. For clients who won’t be leaving a legacy, annuities should be “at the very top of the conversation when you’re talking about asset allocation,” he says.
Sanderson says diversifying across asset and product class during decumulation is as important as during accumulation, and the ALDA offers an additional way to do so.
With an ALDA as part of a portfolio’s fixed income portion, some of the remaining investments could potentially be relatively aggressive, focusing on growth, says Craig Hughes, director of tax and estate planning at IG Wealth Management in Winnipeg. With the ALDA, “you’ve got this hedge, in a sense,” he says, which appeals to clients who don’t like volatility.
However, a growth mandate likely wouldn’t work for lower-income clients, because they wouldn’t want added equity risk, Sanderson says.
ALDA withdrawals are taxable and eligible for pension income splitting and the pension credit. As with any registered product, the earlier the annuitant dies, the greater the potential for tax at death, so clients should consider whether insurance is required to pay tax, Hughes says.
Finally, the ALDA shouldn’t be considered at the exclusion of other annuity options, Sanderson says: “All planning needs to be focused on addressing needs, not choosing a favourite product.”
Can’t buy me longevity?
ALDAs will only be used as a part of financial planning if the product comes to market at an attractive price, says Moshe Milevsky, a finance professor at York University’s Schulich School of Business, adding that companies offering the products must have the highest credit ratings. In the U.S., clients can choose among 10 to 15 insurers who quote on ALDAs, he says.
Potentially indicating industry headwinds for the new product, Manulife announced in June 2018 that it would no longer offer individual fixed annuities. Milevsky says that, if ALDAs hit the market with pricing that isn’t as good as models have indicated, he won’t suggest clients buy them instead of bonds. Though the ALDA is “extremely attractive,” he says, “the jury is still out on whether the pricing will be attractive.”
Full details on ALDAs won’t be known until the government drafts legislative amendments for public comment. Budget 2019 proposes that ALDAs:
- be purchased under an RRSP, RRIF, defined contribution plan, deferred profit sharing plan or pooled registered pension plan;
- have a lifetime limit of 25% of a registered plan, equal to the value in the plan in the previous year plus amounts from the plan used to purchase ALDAs in the previous year; and
- have a lifetime dollar limit of $150,000 from all qualifying plans, rounded to the nearest $10,000 and indexed, and a tax of 1% per month applicable to any purchase over the limit, unless the over-purchase is a reasonable error and repaid to the plan in a specified period.
Tax treatment at death would align with the existing annuity framework. For example, where there’s a lump-sum death benefit to a surviving spouse or financially dependent child or grandchild, it could be rolled into an RRSP or RRIF. With other beneficiaries, any lump sum is included as income on the deceased’s terminal return.
Ron Sanderson, director of policyholder taxation and pensions at the CLHIA, says the ALDA could be more restrictive or flexible than the proposal. Policy discussions about the appropriate trade-offs between flexibility in options and income security will likely continue as the ALDA is developed, he says.