In June 2006, I wrote an article on “variable annuities, the new kid on the block” which dealt with a new retirement income product that might be worth consideration. Until then, a retiree had only a few product choices on how to allocate their retirement savings to provide sustainable income as follows.
1. Variable products such as mutual funds, stocks, bonds or cash can be used to design a portfolio with which to take regular income withdrawals in retirement. These portfolios are subjected to sequence of return risk especially if you retire in a down market and are making regular withdrawals.
2. Guaranteed products such as GICs or annuities can also be used. In the current interest rate environment, GICs have low rates of return and generally do not keep up with inflation. Annuities provide a guaranteed income stream for life, much like a pension. However once purchased, there is no access to the capital and typically no estate value.
Along came the “variable annuity” or what it has been more commonly referred to in Canada as the GMWB, Guaranteed Minimum Withdrawal Benefit. In a nutshell, a GMWB provides guaranteed income for a specific time period with the potential for increased income depending upon the performance of an underlying investment to which it’s linked. It can best thought of as a combination of items one and two discussed above. For this guarantee, you pay a higher management fee i.e. portfolio insurance. Manulife was the first insurer to introduce the product to the Canadian marketplace since it had purchased John Hancock in the US where variable annuities have been used for several years. Canadians have been receptive to the product and now there are many insurers offering GMWBs. Manulife remains at the forefront in not only sales but in product evolution. For more information on GMWBs, I recommend the Manulife microsite at http://manulifeincomeplus.ca/ as a primer.
Advisors need to conduct their own due diligence when new products are introduced to the market.
My major concern from the outset concerning GMWBs was that there were no guidelines on what percentage a client should hold as part of their overall portfolio. One independent advisor, Jim Otar, offers a software tool called “the retirement calculator” that uses historic market data and allows you to model combinations of product allocations which include GMWBs. It’s a great tool that helps determine ( based upon your financial resources today), when you can retire, how much you need to save for retirement, as well as the probability of running out of money in retirement.
Moshe Milevsky, the Executive Director of The IFID Centre (www.ifid.ca) and Associate Professor of Finance at the Schulich School of Business at York University (www.yorku.ca) in Toronto is well known to many Canadians for his numerous books and lectures on money issues. He is also President, CEO & Chairman of the QWeMA Group (Quantitative Wealth Management Analytics Group). Manulife has partnered with QWeMA to develop software to addresses how a client might best optimize their “product allocation” between the following.
1. Guaranteed investments (annuities),
2. Variable investments (traditional RRSPs/RRIFs with systematic income withdrawals in retirement) and,
3. GMWBs.
Based upon the clients expected financial resources at retirement (company pension, CPP, OAS, RRSPs, etc) and the key variable of how much income the client desires in retirement, the software calculates their RSQ (Retirement Sustainability Quotient). Values range from zero indicating a low probability of having sufficient retirement income to last your lifetime to an RSQ of 100 indicating a high probability of sufficient income. Lastly, a modeled scenario with an improved RSQ value (plus allowable product allocation ranges) is presented for consideration.
Defined benefit pension plans continue to decrease for Canadian workers. These investors must take a more active role in their retirement income planning. In my opinion, product allocation is the newest major development that needs to be given high priority in the quest to produce sustainable income throughout retirement.
Don Maycock, P. Eng, CFP, CIM is an independent financial advisor …advising you to and through retirement! Don is licensed for mutual funds which are provided through Armstrong & Quaile Associates Inc and insurance which is provided through Armstrong & Quaile Insurance Agency Inc. If you have a question or comment, email Don at dmaycock@a-q.com, call (613) 966 8289, or go to www.donmaycock.com for more information. Subscribe to “The MAYCOCK e-Newsletter” to receive valuable financial planning tips each month.
Disclaimer:” “Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.”