Managed Money Reporter Newsletter
Editors: Carl Spiess & Allan McGlade
By Allan McGLade, CLU, CFP, CIM, Associate Director, Wealth Management
Over the past 10 years, the investment industry has developed dozens of new products for growth and income. At the same time, an old standard for retirement income — the annuity — was falling out of favour due to persistently low interest rates.
Now annuities are making a comeback in spite of low interest rates. Their renewed popularity is mainly due to volatility in financial markets and the economy. Annuities still have guarantees that are very appealing today, and they enable retirees to marginalize the two major financial risks they will face:
An annuity is a contract you make with a life insurance company, and it functions much like a guaranteed pension. You pay the company a lump sum of money, and they return it to you as monthly payments that combine your principal and their interest. If you purchase a life annuity, the insurance company assumes the risk of maintaining payments until you die. If you die too soon, however, optional guarantees in the contract can make sure you don't forfeit the capital you invested.
One of the lesser-known attributes of an annuity is tax-efficiency. This tax-efficient potential only applies to annuities purchased with non-registered funds. When you purchase an annuity with non-registered funds, your monthly payments consist of a blend of interest income and a return of your capital, or principal. Only the interest portion of the payments is taxable each year.
The return of capital is non-taxable because you have already paid tax on the money before it was invested; in other words, you purchased the investment with after-tax dollars. The tax-free cash flow offsets the effects of inflation and helps to boost purchasing power. And since this cash flow is not considered income for tax purposes, it is possible to have an income stream in retirement that is greater than the Old Age Security (OAS) clawback threshold ($66,733 in 2010) and yet still receive your full OAS benefit.
A potential shortcoming of an annuity is that it will exhaust all of your initial capital if you live a long life, leaving no legacy for your heirs. That's the reason for an insured annuity strategy, in which you purchase the annuity together with a paid-up life insurance policy.
You may think that the cost of the life insurance would make an insured annuity uncompetitive with other retirement income strategies, but that is not the case. The example below illustrates how an insured annuity can provide a 65-year-old couple with equivalent pre-tax yield of about 7.66%, and after-tax income $700 per month more than a GIC alternative.
Annuities are not for everyone, but many people will like the certainty that comes with such a contract — at least for a portion of their retirement savings. If an annuity sounds appealing to you, please email us or give us a call at 416-863-RRSP (416-863-7777) and we can discuss some options.
For more information on annuities, see:
This sounds like an odd question, because both are so important. However, if you had to separate the two and rank them, which would be more important? To be absolutely honest, you'd have to say saving.
Think of it this way. If you lived in a world where there were no opportunities to grow your savings through investments would you still have to save for retirement? Of course you would. Even when there are opportunities to invest your money, a good portion of your retirement assets in the end will still be saved capital or principal. Remember, a good annual compound rate of return on your investments is still just 5% to 10%. Note that investment growth begins to work more in your favour the earlier you start to save for retirement.
If you agree that saving is more important than investing, are you getting the job done? No matter how much you earn or what type of person you are, there is one best way to save. That "best way" is regular, automatic monthly contributions. This approach to saving is called "pay yourself first," and it's not new. You set aside something for yourself before you pay the bills, and then see if you can budget a bit if necessary to accommodate that amount in your monthly cash flow.
If you save for retirement at work through payroll deduction, you know how this works. Should your employer have a policy of matching your contributions, it's definitely in your interest to contribute enough to the plan to receive the maximum match. If your employer doesn't offer a retirement plan, you can create your own "payroll deduction" plan directly from your bank account through an arrangement called a pre-authorized contribution (PAC) plan. Contributions can be made to an RRSP, TFSA, RESP or a regular investment account. The Spiess McGlade Team would be happy to help you set it up.
How much should you save monthly? Ideally, you would start with a defined financial goal like retirement or child's post-secondary education, and work back over the time horizon to calculate the monthly amount that would reach this goal. Sometimes this method can be daunting, especially if the time horizon is relatively short.
Another method is determining what you can reasonably afford. A good rule of thumb is to save 10% to 15% of your annual income, but our recommendation is to set up an initial monthly savings amount that is comfortable for you. If that amount is less than 10%, don't worry. The main idea is to get into the habit of paying yourself first—and then you'll want to raise the contribution percentage up to at least 10% as you see the great results from your discipline.
There are several reasons why PAC plans are the most efficient, effective way to save, but here is one of the most important. Regular saving relieves the pressure to pursue a risky investment strategy, and enables you to follow a more conservative plan knowing that you will still reach your financial goals.
For example, if you need $750,000 for retirement and you only manage to save $250,000, you'll need high-risk investments like individual stocks, sector funds and/or commodities to even think of reaching that goal. However, if you are able to save $600,000, you can relax with balanced and income investments that have a much better chance of lifting you up to the $750,000 you need.
If you think you can do a better job of saving, please email us or give us a call at 416-863-RRSP (416-863-7777). We'll help you calculate a monthly amount to save, and set up a savings plan that will work best for you.
And speaking of investing, both September and October, defied the old myth that they are bad months for stock markets. Canadian Equity mutual funds followed up their strong September with positive returns in October, as global currency markets anticipated softening of interest rates from the US Federal Reserve which met November 3rd. All categories reported gains. Performing especially well in anticipation of future declines of the U.S. dollar were commodities and resources. Click on the link to our fund performance tables to see more details. Also, our Scotia analysts have also updated their reports for Q4/2010, see link below to Investment Portfolio Quarterly:
Are mutual funds really less expensive to own in the U.S. than in Canada? This so-called fact has gone unchallenged by the Canadian mutual fund industry for decades, until Mackenzie Investments recently commissioned an independent researcher to find the truth. The verdict: An "apples-to-apples" comparison shows that the majority of investors in Canada and the U.S. incur a comparable cost of ownership when purchasing mutual funds with the assistance of an advisor.
Why has this taken so long to discover? The difference in the structure of fees between the two countries has masked relative parity in the level of fees. Front-end load charges are a prime example. They exist in Canada, but are rarely charged. In the U.S., however, front-end load charges are specified in the prospectus and are always charged. Canadian media and investors who focus only on management expense ratios (MER) in this country ignore the presence of U.S. front-end load charges.
Another "expense" present in Canada (but not in the U.S.) is sales tax. Canadian mutual funds are subject to GST, and HST in provinces that have adopted it. GST alone accounts for about 0.10% of incremental cost of ownership difference between the two countries.
This study was conducted in 2010 by global business consulting firm Bain & Company. Within the four most popular categories of mutual funds—domestic equity, international equity, balanced, and fixed income—the study compared the average Canadian cost of ownership with costs from a cross-section of 14 U.S. mutual fund providers. Canadians enjoyed a distinct cost advantage in the fixed income category, and were middle of the pack in the other three categories. Canadian cost of ownership was highest on a relative basis in the domestic equity category.
The mutual fund distribution system was also found to be very different between the two countries. Americans were more inclined to use direct/discount brokers and fee-based advisors than Canadians, while over a quarter of Canadians buy their mutual funds through bank branches. Bank branch distribution is non-existent in the U.S.
To read the full report, follow the link below:
The Investment Industry Regulatory Organization of Canada (IIROC) is the national self-regulatory organization that oversees all investment dealers and trading activity on debt and equity marketplaces in Canada. Created in 2008 through the consolidation of the Investment Dealers Association of Canada and Market Regulation Services Inc., IIROC is an important part of consumer protection for the investment industry.
The old registration system for brokers and advisors has been transformed into a new web-based investor tool called AdvisorReport. AdvisorReport lets you check on several aspects of your advisor's credentials, including
The report also exposes any IIROC disciplinary actions, and requires advisors to disclose any non-IIROC disciplinary actions.
We like AdvisorReport, because it provides background information about the Spiess McGlade Team that would not come up in the course of most conversations. If you would like to have a look at AdvisorReport, please follow the link below.
Many investors have come to understand the concept behind social/ethical funds. Now the Global Iman Fund offers an investment alternative that follows Islamic investment principles by avoiding interest-based investments and excluding certain industries. The Global Iman Fund is offered by Global Prosperata Funds Inc.
One of our preferred mutual fund managers, Fidelity Canada, has expanded its line of fixed income funds with three new product offerings. Two of them are capital yield funds that convert interest income into capital gains: one being a private investment pool, and the other a corporate structure class. The other offering from Fidelity is a new corporate bond fund.
The successful rescue of 33 Chilean miners is definitely the feel-good story of the year. In the spirit of that event, our link of the month is a web site that only posts good news stories. The bad news is that it's a pay site that will ask you to register for a membership, but the good news is that they offer a free trial. We thought you might like to know about it.
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