Jeff buckstein
Globe and Mail Update
Published Saturday, Feb. 25, 2012 6:00AM EST
Last updated Tuesday, Feb. 28, 2012 8:24AM EST

Canadians who own registered retirement savings plans recognize the critical importance of building and maintaining value within their RRSPs. But comparatively few think about the need to protect their RRSP against potential creditors, or understand the degree to which they are covered could depend on the jurisdiction in which they reside.

Those most at risk are likely “self-employed people, owners of corporations, and professionals who might be subject to unlimited liability. Even those professionals who are incorporated are still subject to personal liability,” warns chartered accountant Robert Snowdon, who runs a CA firm in Kanata, Ont.

Cognizant of that reality, and recognizing the prudence of planning ahead for unforeseen events, Mr. Snowdon protected his own RRSP assets in the past by putting them into a segregated fund as part of a 10-year life insurance contract.

RRSP and registered retirement income fund (RRIF) proceeds held under any life insurance contract are generally fully protected from creditors, provided the proceeds have not been deposited fraudulently to avoid paying creditors, and so long as the insurance policy names a beneficiary.

Certain RRSP and RRIF holdings are also protected from creditors under a provision of Canada’s federal Bankruptcy and Insolvency Act, which came into force in July of 2008. This act provides protection under specific circumstances involving bankruptcy.

It covers situations where “a trustee takes over an individual’s financial affairs once they have been petitioned into bankruptcy by their creditors, or the individual makes a voluntary assignment in bankruptcy because they can’t pay all their creditors,” explains Jack Courtney, assistant vice-president of advanced financial planning with Investors Group Inc. in Winnipeg.

However, this act also contains an important timing proviso. A trustee can claw back, or seize, RRSP or RRIF proceeds contributed within 12 months of the date of bankruptcy.

Somewhat complicating the matter is the existence of provincial legislation in jurisdictions such as British Columbia, Alberta, Saskatchewan, Manitoba, Prince Edward Island, and Newfoundland and Labrador that also specifies RRSP and RRIF assets are generally protected from creditors. Other jurisdictions might provide protection under certain circumstances. However, most of these provincial laws do not contain a time provision exempting certain deposits (B.C. is an exception, mirroring the 12-month federal period).

“In most provinces that exempt RRSPs from seizure, the clawback will not apply. So if you’re in a province that always exempted RRSPs, the fact that federal law in bankruptcy has now changed does not alter the status of the injection of RRSP money in those provinces in the previous 12 months,” Toronto lawyer Fred Tayar explains.

When Mr. Snowdon’s segregated-fund insurance contract expired, after the Bankruptcy and Insolvency Act was in force, he decided against establishing a new insurance contract to cover his RRSP proceeds, electing instead to transfer the full amount to a new self-administered RRSP.

There were a couple of other things he wanted to change. Within the insurance contract, Mr. Snowdon felt his management fees for transactions were higher than those of other RRSPs, as a result of guaranteeing at least 75 per cent of the value in the segregated fund. He also felt restricted to a selection of only five or six mutual funds.

There is a trade-off for the added protection, experts say.

“The more guarantee you buy, the more expensive the underlying fee associated with the product will be,” Mr. Courtney explains. “You can buy segregated fund products that have very minimal guarantees where the pricing is very comparable to mutual funds, and many of them will almost mimic an underlying mutual fund in their investment mandate and the way they are managed,” he says.

Those who do elect to put their funds into an insurance product have all the same flexibilities built in as they would in an RRSP held with any other financial institution. Plan holders can take out money for an emergency. At age 71, they can also make the same choices available to RRSP holders with a bank or elsewhere; convert their RRSP proceeds into their choice of a RRIF (if they want to continue managing their funds with a similar degree of autonomy and risk, with the same investment portfolio), or convert the proceeds into the certainty of a fixed income annuity.

“A segregated fund will typically have a maturity date within the contract. That’s going to be at the end of the year that you’re 71, but the investment is open ended until that time. They really are designed as lifetime arrangements, and [they are] liquid at any time,” says Ron Sanderson, the Toronto-based director of policy holder taxation and pensions for the Canadian Life and Health Insurance Association Inc.

February 22, 2012 By Robb Engen

Mortgage life insurance is marketed by the banks as a flexible, low-cost way to protect one of your largest financial obligations. If you face a terminal illness, or have a serious accident, mortgage life insurance can help you out. It will pay for such things as:

The outstanding mortgage principal amount, up to $500,000
Up to five years of accrued interest, and
Any debit balance in your tax account

The concept behind mortgage life insurance is a good one. It protects your family against unexpected illness, accident, or death.

Related: What happens when you miss mortgage payments?

However, I declined the bank’s insurance coverage when we purchased our new home and kept enough term life insurance to protect my family.

Here’s why:

Mortgage life insurance is the one financial product that goes down in value as you continue to pay, yet this is promoted as a benefit. The marketing material says: your premiums will not increase for the term of your mortgage, even as you get older. It’s comforting to know that this important coverage will remain affordable.

But that also means that relatively it costs more over time. As the mortgage principal decreases the cost stays the same. That’s called a declining benefit.

The monthly mortgage insurance costs for a 30-something couple with a $300,000 mortgage can range from $75 – $120. Four years into a 25-year mortgage with a four-and-a-half per cent interest rate, your outstanding mortgage balance will be reduced to $270,000, but you will continue to pay the same mortgage life insurance premium.

On the other hand, a $600,000 5-year term life insurance policy only costs about $50 per month for a 30-something non-smoker. You get twice the coverage with term life insurance for half the cost of mortgage life insurance.

Life insurance also protects more than just your mortgage, which is just one expense your family will face if you die. Other family needs can include funeral expenses, your children’s education, and income replacement.

Life insurance gives your surviving spouse or beneficiary the option of paying off the mortgage or using the payout for other purposes. With mortgage life insurance, the bank is the beneficiary and only the mortgage will be paid off.

Mortgage life insurance is not a requirement to qualify for a mortgage and term life insurance is much cheaper and offers greater protection than the mortgage life insurance offered by your bank. That makes it my choice.

Question: I just don’t understand annuities. There seems to be a lot of buzz about their guaranteed income as a crucial piece of any retirement portfolio. But if I have $100,000, then I already have guaranteed cash to pull from that is not subject to fees or penalties. And I may benefit from higher interest rates in the future. So why would I buy a $100,000 annuity? What am I missing?

Answer: Winston Churchill once described Russia as “a riddle wrapped in a mystery inside an enigma.”

As far as many investors are concerned, he might just as well have been talking about annuities. They’re probably the single most misunderstood investment around, in large part because there are so many varieties of them, many of which contain arcane features that can numb the brain.

I’d like to answer your question, not so much to tell you categorically that you should invest in an annuity, but to suggest why you might want to consider putting some of your money into a particular type of annuity known as an immediate annuity.

Running the Numbers

Let’s start with your $100,000. You don’t say how old you are, but just so we can use specifics, I’ll assume you’re 65.

If you put that hundred grand into an immediate annuity today and select the lifetime income option, you would receive about $660 a month for the rest of your life.

The amount of lifetime income an annuity pays depends mostly on your age and the level of interest rates when you buy. But the size of the payments will also vary somewhat by insurer, with some companies paying more, others less.

As you note, rather than buying an immediate annuity, you also have the option of investing your $100,000 on your own and drawing income from your stash. If you go this route and want a high level of assurance you’ll get income for life, you’ll likely want to keep your money in something that’s very secure, such as long-term Treasury bonds or GICs, which recently yielded about 4.6%.

So let’s assume that instead of getting an annuity, you invest your money in a pool of Treasury bonds and then systematically withdraw enough principal and interest each month to duplicate the annuity’s $660 monthly payment.

If you did that, however, you would run out of money before you hit age 84. If you wanted to assure that your $660-a-month payments would last until age 85 — roughly the life expectancy for a 65-year-old — you would have to invest $105,000 in those Treasuries.

But approximately half of people live beyond life expectancy. And if you wanted to count on those $660 monthly payments coming in until age 95, you would have to put just over $130,000 into Treasuries. Live beyond 95, though, and you’ll run out of dough. The annuity, on the other hand, pays as long as you live.

How, you may ask, can an annuity make these larger payments and guarantee them for life? The answer lies in what are known in insurance circles as “mortality credits.” Insurers know that some people who buy annuities will die before life expectancy, while others will live longer. That allows insurance companies to increase annuity payments by essentially transferring the money from the people who die early to those who die late.

Of course, you could try to boost the income you get from your $100,000 or the period of time it will last (or both) by investing in assets, such as stocks, that have a higher return potential than Treasuries.

But that would subject you to greater risk. If things work out in your favor, you might do fine. But if you run into rocky markets and take some losses — especially early in retirement — the combination of investment losses and withdrawals could deplete your portfolio pretty quickly.

As for your comment that by holding onto your $100,000 rather than buying an annuity you “may benefit from higher interest rates in the future,” that’s true. But the operative word is may. Maybe rates won’t rise and you won’t benefit.

Even if rates do go up, it’s not a given you’ll end up with more income. It depends on how you invest.

If you invest in something like a money market account or short-term CDs, then rising rates would translate into more income (although in the meantime, you’d have to draw out much less than with an annuity given the low yields of money market accounts and CDs). But if you invest in stocks and bonds, rising rates would likely reduce the principal value of your portfolio.

So to reinvest your money to take advantage of higher rates, you would have to sell your existing investments at a loss, leaving you with less to reinvest. I doubt you would be better off, and you might be in a worse position.

Even the Treasury scenario I gave above probably overstates your ability to duplicate what an annuity does. Why? Well, at current yields, $100,000 in Treasuries won’t throw off anything close to $660 a month. Which means you’d have to sell off Treasury bonds periodically to match the annuity’s income.

You’d then run into the issue of what price you’d get when you sell. If rates have gone up, the market value of the bonds would fall.

The Downsides

Once you buy an immediate annuity, you get guaranteed lifetime payments but typically lose access to your principal. So you can’t tap that $100,000 for emergencies and such.

Plus, the insurer you’re relying on to make those annuity payments years into the future could run into financial problems, jeopardizing your income.

And let’s not forget what I call the “rogue bus scenario” — i.e., the worry that shortly after buying the annuity you’ll get hit by the proverbial bus. In that case, you’ll have shelled out big bucks, gotten only a few payments and left nothing to heirs.

But I think these issues are pretty easily dealt with. How?

By putting only a portion of your money into an immediate annuity, you have a stash that can provide liquidity for emergencies. You can also invest for long-term growth so you can maintain your standard of living as you age.

How much is enough? That depends on individual circumstances, but one guide is that you may want to devote enough to an annuity so that the combination of payments from Social Security, any traditional pensions you have plus the annuity income cover the bulk of your basic living expenses.

When it comes to protecting yourself against the possibility of an insurer being unable to make annuity payments, there are several lines of defense. You can stick to insurers with high safety ratings. You can also diversify — that is, split whatever money you’re planning to “annuitize” among the annuities of a few insurers.

And you can make sure that the amount you invest in an annuity with any single insurer is within the maximum covered by your state’s insurance guaranty association. (By spreading out your purchases over time, you can also diversify against the risk of putting all your dough into an annuity when interest rates are abnormally low.)

As for the idea that you’ve wasted your money if you die soon after buying a lifetime annuity, that money is no more “wasted” than the money you paid to insure your house even though it never burned down.

Which brings us to the central difference about generating income from your savings by yourself vs. buying an annuity: unless you’re willing to take more investment risk, you as an individual can’t match the guaranteed income an immediate annuity can provide.

This is probably one of the few statements that you can get most economists to agree on, as two Wharton finance professors pointed out in this policy brief on investing for retirement.

Bottom line: you may already have “guaranteed cash” in the form of $100,000. But there’s a huge difference between that and having guaranteed income for life.

Warren Blatt is an independent financial advisor at WDB + Associates

As a derivatives trader, nobody more than myself enjoys coming up with sophisticated investment strategies. Yet, sometimes opportunities presents themselves in ways that don’t require a whole lot of complexity nor hours of research. And while I strongly believe there are no free lunches out there, sometimes you do find a $5 bill or even a $20 bill lying on the street. An insured annuity is one of those very simple, easy to understand products that complement the fixed income portion of one’s portfolio.

So, what is an annuity? It is a contract, usually between an insurance company and an “annuitant” who, for a lump sum payment, will receive from the insurance company, a stream of income for life — very similar to the benefits of owning a long term bond or perpetual preferred share.

So what is an insured annuity? An insured annuity is simply an annuity in combination with a life insurance policy. One of the disadvantages with owning an annuity without the insurance policy is that once you hand over the cheque to the insurance company, you don’t get your money back. An insured annuity solves this problem. Basically upon death, the annuitant’s estate receives the principal amount back — again very much like a bond that upon maturity pays back the principal amount.

Now, there are various types of annuities, and many factors that need to be considered in determining the appropriate type of annuity.

Single Life Annuity

A single life annuity will provide you with an income for as long as you live, ensuring that you will never outlive your money. It can also be guaranteed for a certain number of years. Should a premature death occur, the estate will continue to receive the funds at least up to the guaranteed period.

Joint and Last Survivor Life Annuity

This life annuity is payable while either you or your spouse (or common-law partner) are living. When one spouse dies, the survivor can continue receiving income payments as agreed upon when the annuity contract was established. As with the single life annuity, a guarantee period can be written into the contract.

Term Certain Annuity

This type of annuity can be useful for planning ahead when you will require a specific or additional income for a pre-defined period. A term certain annuity provides you with an income for a set period, or until a certain age.

How Life Annuity Payment Amounts Are Calculated

The life annuity payment amount is fixed and is based on:

• the amount of money used to purchase the annuity,
• the type of life annuity purchased,
• current interest rates,
• the ages of the annuitant and joint annuitant, if any,
• current long-term bond rates.

Tax Efficiency

Perhaps the greatest benefit for considering an annuity is for the tax efficiency of the prescribed annuity when using “non-registered” funds. The CRA recognizes that payments received as income from an annuity include both interest and principal. Since taxes have already been paid on the principal, the annuitant will not be taxed twice.

For example, if one purchases a life annuity for $1,000,000 and receives an annual income of $80,000, the amount that is taxable might be $18,000 (actual income and taxable amount will be based on conditions when an annuity is purchased). That leaves the investor with $62,000 on an after tax basis.

However, in order to complete the financial analysis, we have to factor in the cost of the insurance policy. Again, it will depend on the individual but for this example, let’s assume the cost of the insurance policy was $15,000. This would reduce the investor’s income from $62,000 to $47,000 on an after tax return basis.

In comparison, an affluent, wealthy investor would have to earn at least 8% from his bond portfolio in order to match the after tax return of an insured annuity. Given that most investment grade corporate bonds are paying closer to the 5-6% range, the insured annuity outperforms by a landslide.

In summary here is what an Insured Annuity can do for you?

• Provide a regular, guaranteed income stream for both you and your spouse for as long as both of you live.
• Create a tax advantage
• Ensure your principal is returned to your estate upon death
• Reduce market risk to investable assets by treating an annuity as part of the asset allocation strategy of the portfolio.

Are there any disadvantages to an annuity? It’s a non-cancellable contract, and technically you lose control of those funds. The contractual payments are fixed and will never increase — hence annuities are subject to inflation risk which is why we at Frontwater believe they are a complement to a portfolio weighted towards fixed income.

Certainly, as stated above, if for no other reason than continuing market volatility, and your expectations of a long life, a look at including an annuity within your overall investment strategy might be worth a consideration.

Whenever, I speak about insured annuities, I am reminded of the story with Leonardo da Vinci and the Pope. The story goes that the Pope requested that Leonardo da Vinci submit a piece for a new commission. Leonardo drew, freehand, at arms length, a perfect circle on a sheet of paper and sent it to the Pope, who promptly gave him the commission. For those who don’t know, to draw a perfect circle, freehand and unsupported is one of the hardest things possible to draw — all the more reason to admire beauty in simplicity.

To find out more about insured annuities, please contact Warren Blatt at 416-319-8172.

Author: Jeff Kaminker
www.fwcapital.ca