How to Invest When You Might Live to 100
22 Apr 2022.
Last November, Gertruda Gorecka turned 110 years old. While Gertruda may have the notoriety of being Canada's current oldest person, more and more Canadians are reaching that 100-year milestone. And although a long life in general is obviously appealing to many, it complicates retirement planning.
One of the biggest concerns retirees face is outliving their savings. Unfortunately, only a few Canadians have access to a defined benefit pension plan, leaving most with the responsibility of deciding how to use their savings to finance their lifestyle for as long as they live.
This article explores the investment options for retirees to receive lifetime income, the pros and cons of each, and introduces a retirement investment concept that is taking the retirement industry by storm.
First, let’s start with lifetime annuities. These products provide a guaranteed level of income for life. Investors will know precisely how much income they will receive once they purchase the annuity. Some also offer certainty periods or include joint survivor options. And because they are backed by the balance sheet of insurance companies and non-profit associations, they are effective products for securing lifetime income.
The trade-off, however, is the irrevocable nature of the product and the lower yield they offer. Typically, if you purchase an annuity, the purchase is final: you cannot change your mind or get any of your money back in the event of early death. This can cause investors to feel like they’re making a significant bet against an insurance company on the timing of their own mortality. And the cost of having the income level guaranteed is that it’s set far lower than what many retirees expect and does not increase over time despite strong returns in the market. These factors make annuities a less popular choice among retail investors.
Guaranteed Minimum Withdrawal Benefit Funds
Another option is Guaranteed Minimum Withdrawal Benefit funds (GMWBs). These blend investment funds with an insurance wrapper that provides the potential for market gains while guaranteeing a minimum level of income for life.
Similar to annuities, they provide guaranteed protection against outliving your savings. Where annuities lack in revocability, GMWBs allow investors to change their minds about the investment and access the funds in their account at any time.
So, what’s the trade-off? Due to the insurance components embedded in these products, the fees can become quite high, which ultimately leads to lower lifetime income rates for investors, which are typically around 4% for a 65-year-old. These products have waned in popularity over the past two decades. Since the financial crisis, three of Canada’s biggest life insurers have either exited the GMWB market or limited their exposure.* These products may also come with penalties for early withdrawals.
Traditional Mutual Funds and ETFs
Most often, retirees generate retirement income using a combination of mutual funds, exchange-traded funds (ETFs), and possibly a selection of individual stocks and bonds. This strategy provides liquidity and diversification and is reasonably effective when paired with sustainable income sources from government-sponsored programs (e.g., Old Age Security, CPP/QPP).
The challenge with this approach comes back to concerns around outliving your savings, as these products do not provide any longevity protection. Because individual investors are left to bear the risks themselves (including investment, sequence of returns, and mortality risk), it can very well lead to a depletion of assets well before the investor passes away, leaving them feeling unsettled in retirement. Conversely, this fear leads many retirees to withdraw too little, spending frugally during retirement and passing away with significant unspent assets.
The Future of Retirement: Income for Life Without the Insurer's Guarantee
A unique category of retirement products incorporates the concept of longevity risk pooling, which pools investors with a common goal of securing income for life and sharing the risks to combat outliving their assets. The principle behind this risk pooling concept is simple: to enjoy a higher level of income for the rest of your life, you must give up some (or all) of it when you pass away.
The benefit of this arrangement is that by effectively not putting a guarantee on the income levels, investors can directly benefit from a considerably higher expected income rate than if the cost of an insurance guarantee was embedded in the product. They may also offer more flexibility, giving investors the option of changing their minds and exiting the investment if an unexpected life event occurs. The trade-off is that the higher levels of income the investors receive will fluctuate, which depends on the funds' performance and the pool's mortality experience.
This category of retirement products has gained significant attention and support from retirement experts and organizations across the globe. Below are some of the examples that exist today:
As displayed above, more recently within the retail space, we launched the Longevity Pension Fund (LPF). The world’s first income-for-life mutual fund, LPF gives any investor access to this type of lifetime income solution. An LPF investor benefits from an attractive lifetime income stream, starting at 6.15%, with full access to their unpaid capital** if they change their mind or pass away early. The goal is to provide the peace of mind that comes with an attractive lifetime income without having to feel like you’re irrevocably handing over a large portion of your savings.
These products can be very effective solutions to incorporate into a retirement portfolio and something to consider for those concerned about outliving their savings. The following table summarizes the benefits and trade-offs of these solutions:
The best approach is to diversify your portfolio. A combination of these products can certainly help you achieve your post-retirement goals. To read more about retirement planning, check out the following articles: Beating Inflation in Retirement Starts with a Plan, A New Alternative to Annuities, and Income for Life: How It’s Possible
**Unpaid capital is an investor’s initial investment less the total distribution payments received
This article is not investment advice, nor is it tailored to the needs or circumstances of any investor. Talk to your investment advisor to determine if the Longevity Pension Fund is right for you and always read the prospectus before investing. Commissions, trailing commissions, management fees and expenses all may be associated with the Fund. Investments in the fund are not guaranteed, and the Fund’s value may change frequently. Past performance may not be repeated. Income in the form of Fund distributions is not guaranteed, and the frequency and amount of distributions may increase or decrease. The Fund has a unique mutual fund structure. Most mutual funds redeem at their associated Net Asset Value (NAV). In contrast, redemptions in the decumulation class of the Fund (whether voluntary or at death) will occur at the lesser of NAV or the initial investment amount less any distributions received.