The LRIF, Or Annuity, Decision
By: Asaf Shad
The rise of money purchase plans has meant more decisions must be made by pension plan members. However, those decisions don’t end on retirement. Asaf Shad, of Acquaint Financial, looks at some of the factors each retiree must consider when deciding where to put their retirement funds.
Just as the popularity of money purchase plans has increased in recent years, so have the number of visits to human resources and pensions and benefits staff by confused pension plan members trying to make sense of their retirement options. One of the most significant retirement options that plan members have is making the decision to either purchase an annuity or move their funds into a LRIF or LIF. While both have their advantages and disadvantages, a prudent decision must be made by the member based on their personal situation.
But before we get into some things that must be considered to make this decision, we must first define what LRIFs and LIFs are.
An LRIF, or Locked-in Retirement Income Fund, is governed by Alberta, Manitoba, Ontario, or Newfoundland legislation and is a tax-sheltered retirement income vehicle with legislated minimum and maximum annual withdrawal amounts. The funds originate from locked-in funds under a registered pension plan or Lockedin RRSP/LIRA. It is designed to provide income throughout retirement.
A LIF, or Life Income Fund, is a tax sheltered retirement income plan with legislated minimum and maximum annual withdrawal amounts. The funds originate from locked-in funds under a registered pension plan or locked-in RRSP/LIRA. In most provinces, a LIF must be converted to an annuity at age 80. The exceptions are New Brunswick, where the age is 90, and Quebec, Nova Scotia, and Manitoba where it does not apply.
While this may seem quite straightforward, planning an income stream for retirement requires considerable thought and time. By considering some key points and deciding which categories they fall into, employees can often make the right choice.
Some important questions employees need to take into consideration when making these choices include:
- Do I want to exhaust my assets or leave some behind for my estate?
- What is my risk tolerance?
- Where will my retirement income come from?
- Am I comfortable with choosing investments?
- Am I semi-retired or completely retired?
- What is the life expectancy of my partner and I?
- Will my situation change?
Since annuities are designed to provide income for a fixed period of time, usually for the life of the purchaser, and perhaps their partner, there is no residual value once the person (and maybe their partner) has passed away. To help meet monetary estate issues, either an LRIF/LIF alone or in combination with an annuity should be considered. Monies held inside a LRIF/LIF are only reduced when drawn from (subject to annual minimum amounts) and thus can offer an estate a certain sum of money. Remember that LRIF/LIF cash outs upon death are taxable.
Risk tolerances often change when people enter retirement. During earlier stages in a person’s life, they are usually more willing to accept some risk. As a person enters into retirement, their willingness to accept risk decreases. This is with good reason. In the market crash of 2001/2002 many individuals lost substantial amounts of their investment portfolios and had to delay their retirement.
For those people that are looking to mitigate their risk completely and who want a guaranteed income stream, an annuity would be the answer. That is not saying, however, that an annuity is without risk. There is a risk of purchasing an annuity when interest rates are low and once you purchase the annuity interest rates begin to rise. This is often referred to as interest rate risk. There is also the risk of rising inflation outpacing the return on your annuity which is called inflation risk.
For those that are willing to accept more risk, an LRIF/LIF may be the way to go. Keep in mind that LRIF/LIFs operate similar to RRIFs and can hold a wide variety of investments, even less risky ones such as income funds and GICs.
Sources Of Retirement Income
The risk that an employee is willing to accept when deciding on their retirement income stream may depend on their sources of retirement income. Almost all retirees have some private registered and non-registered savings and government plan such as CPP/QPP and OAS. Depending on their working career, if an employee has other pensions, such as a Defined Benefit pension plan, also providing income, they may wish to elect for an LRIF/LIF to have better control over when they use those sources of funds. Control over income in retirement is one of the biggest advantages that an LRIF/LIF has over an annuity. You can control how much income you are going to take and when, within the minimum and maximum amounts you can withdraw each year. So if you are receiving a higher income stream from other sources one year, such as your non-registered investments, then you can lower your LRIF/LIF payments (subject to the minimum amount you must withdraw each year). This is an effective way to control the amount of taxes you pay in a given year. Annuities do not afford you the ability to do this.
Comfort With Investing
There are a number of people out there who are not comfortable with making investment decisions and taking on the associated risks. In fact, this type of person would probably be willing to accept a smaller income stream in retirement if that smaller amount is guaranteed compared to larger income stream that is not guaranteed. In this case, an annuity would provide that level of comfort. This is where the popular saying, ’if you can’t sleep at night, it is probably not a good investment for you’ comes in.
For those are interested in making their own investment decisions, even in retirement, an LRIF/LIF would be the right choice. Important consideration must be given to this topic. An employee may overestimate their willingness to take on risk. While receiving a full-time salary, investors are often more willing to take on risk. When that salary ceases, or is substantially reduced, there is not much room left for risky investments. Managing this risk, overall, constitutes comfort with investing.
Working Considerations In Retirement
Many employees choose to retire from their full-time jobs but plan on pursuing a part-time or second full-time career whether it be in a field of their expertise, pursuing a hobby, or volunteering. An important thing to keep in mind is if you purchase an annuity, start working, and then want to change your annuity because your income is too high, it cannot be changed because the income paid is fixed. With an LRIF/LIF, the amount of income can be customized to meet evolving needs. These needs can range from a second career which goes on for a few years or income fluctuations as a result of seasonal employment. Earning an income through a second year while collecting income through an annuity may put this person into a higher income bracket. This could increase the taxes they pay while lowering other benefits (Old Age Security as an example) when they might not even need the income.
How Long Will The Income Be Required?
One of the worst fears retiring people have is the question of whether they will outlive their money or vice versa. Income from a Life Annuity is guaranteed for the life of the purchaser. There are also some attractive additions that can be purchased which further guarantee the income for any surviving partner and even for a specified term after death. With an LRIF/LIF, the amount of income will likely decrease over time as the assets within the plan are drawn upon. If a couple are counting on a certain life expectancy or supplemented retirement income through a part-time job, drawing down too quickly on a LRIF/LIF may have serious consequences for a surviving spouse after an unexpected death.
Is The Situation Expected To Change?
Let’s suppose a retired couple is thinking of spending a few years abroad, for example in Europe, and then returning to Canada and repeating this cycle. Perhaps their income needs will be higher while they are away but whenever they return to Canada, their income needs drop until they are ready to travel again. An LRIF/LIF would allow the couple to adjust their income as needed. The annuity would remain as fixed income regardless of whether their income needs increased or decreased.
So Which Is Best?
There is no doubt that both annuities and LRIF/LIFs have their advantages and disadvantages. It may seem that for every explanation another question arises which leads to perhaps the most important decision your employees will need to make – ‘which one is right for me?’
Although there is no quick and guaranteed answer, providing them with the proper information and education and then suggesting they consult with a financial professional is prudent. When providing an inquiring staff member with any type of information, it is crucial to ensure that this information is from an independent and unbiased source. All too often employees are given misinformation or mislead because the person giving them the information has ulterior interests.
Enough cannot be said on the value of providing employees with the proper type of financial education from the proper source and underscoring the importance of seeking independent financial guidance. Your employees will thank you for it.
Asaf Shad is president and chief executive officer of Acquaint Financial.
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