As for RRIF asset allocation, Lovett-Reid is “still a fan of equities in your portfolio. You could spend a third of your life in retirement and want to keep up your purchasing power. What if you live too darn long? Longer life expectancies require the growth potential that stocks offer over time.”
She concedes it might make sense to gradually reduce stock holdings to 30% or 40% as you age, depending on health and income requirements. But, she warns retirees to be cautious about being too conservative: “You want to keep up purchasing power, and consider dividend-paying stocks or low-volatility funds for stability and income.”
I also asked occasional MoneySense contributor Dale Roberts for his ideas on de-risking. Roberts, who runs the Cutthecrapinvesting blog, likes the idea of retirees using defensive equities in concert with bonds, cash and gold. “We can look to low-volatility ETFs such as ZLB-T for Canadian equities. The defensive sectors are consumer staples, XST-T, utilities, ZUT-T, and healthcare. Given that there’s no healthcare sector to speak of in Canada, we’d look to U.S. and international options.” Generally, retirees take on too much risk and so could benefit with a “modest allocation” to annuities, says Roberts.
Calculate hurdle rates before deciding on annuitizing
Matthew Ardrey, Senior Financial Planner with Toronto-based TriDelta Private Wealth, also believes annuities may still play a role for some clients. But, before annuitizing a RRIF, “I would strongly recommend completing an analysis to see what the hurdle rate is before making a permanent decision that will affect someone for the rest of their retirement.”
Ardrey defines the hurdle rate as “the minimum acceptable rate of return required for an investment or project to be deemed worthwhile. It serves as a benchmark, and if an investment’s expected return falls below the hurdle rate, it’s generally not considered acceptable.”
Cashing in 20% to 30% of a RRIF for an annuity is “a material amount of most Canadians’ net worth and it is worth understanding what they are receiving for it.” You need to examine and understand various options that will affect how much the monthly payment is (i.e. guaranteed payment period, survivor benefits, inflation protection). “Based on the options chosen and an assumed life expectancy, we can forecast a future stream of payments for the retiree. The higher the rate of return calculated, the better the annuity option is versus the opposite for a lower rate of return.”
If a Canadian investor has just a 3% hurdle rate, Ardrey suggests the RRIF is the better option but if the hurdle rate is 8% the annuity is preferable. “To assume an investor can average 3% per year is very reasonable versus 8% per year, which is much more difficult. Even if the investor has a 5% to 6% hurdle rate, it can be that the RRIF is the better option. If your portfolio has a yield of 4% from dividends and interest, which are relatively stable, then all you need is another 1% to 2% to meet the hurdle rate from capital appreciation, which does not seem like an out-of-reach target in my mind.”
As in all things financial, it helps to know the answer to the impossible question of when an investor will die. “The longer they live, the better the annuity is. If they die prematurely, though, then keeping the capital in the RRIF is the better option.”
