Regular readers of this column will know that I am a big fan of RRSPs. Used correctly, they are usually the premier retirement savings option for high income employees.
But, as with everything that is good, there will be the critics. And one of the things that critics will say is that you have to turn your RRSPs into a taxable income stream by the end of the year that you turn 71. Potentially this means paying tax on money that you may not need, or having income-tested government benefits clawed back.
If the idea of forced withdrawals from your retirement plan sounds nasty to you, let me reassure you that this is usually more of a theoretical problem than an actual one. It is undeniably true that with the tax-sheltered growth of RRSPs you absolutely can grow your money into a very large amount, and if you have to pay tax on a very large amount then the tax bill will be proportionate.
But here is the difference between theory and practice. What I have found is that the people who have a lot of money usually want to spend a lot of money. Usually people aren’t taking money out of their retirement plans because they are forced to by the mandated RRIF minimums. People are taking money out because they want to enjoy their retirement.
Still, it is true that mandatory withdrawals by age 71 may not always be optimal. Which brings me to this week’s topic. The retirement option that nobody knows about. The Advanced Life Deferred Annuity, or ALDA.
An ALDA allows you to take a portion of your registered money and push the income start date out as late as age 85. This offers some relief for the forced withdrawals early in retirement, which can create unnecessary taxable income and exposure to government benefit clawbacks.
An ALDA allows you to reduce those withdrawals by carving out up to 25 percent of your registered assets, subject to a lifetime cap of about $180,000. That portion no longer generates forced income during the early years of retirement.
While the tax planning may be interesting, the real reason why ALDAs were created was so that people don’t run out of money in retirement. With an ALDA you are locking in a future income stream that will pay you for the rest of your lifetime. ALDAs are insurance against longevity. You can’t outlive your money.
Not everyone is concerned about longevity risk, but you probably should be. People are living longer and longer, and with modern medicine you can survive things that used to be fatal.
But living longer exposes you to the risk of running out of money. Especially in a rising cost world. On that note, have you seen the price of gas lately? Is your money keeping pace with inflation?
Here’s what the planning might look like. Your retirement is not likely to be static.
In the early years you are probably still relatively healthy, and now you finally have both the time and the money to do all those things that you always wanted to, but couldn’t because up until now you were too busy with work. During this stage in life you probably want flexibility. TFSAs and RRIFs are appropriate income vehicles to match your lifestyle.
Later in retirement you are likely to slow down. Your health will probably deteriorate. You probably aren’t travelling so much. Now you are not spending as much on discretionary expenses. But you probably are spending more money than ever on health care.
Now you want predictability from your money to make sure your basic needs will be covered for your lifetime. This is the type of scenario where ALDAs can be appealing. ALDAs will produce pension style income that you can’t outlive, with no market fluctuations to worry about. That can allow you to spend more confidently in your 60s and 70s, knowing that a baseline income will be there in your 80s and beyond.
The ALDA is locked in, which is both the strength and the weakness. You have a guaranteed income for life. But you lose flexibility. The decision is permanent. Once you buy it, you cannot change it. You cannot surrender it. You cannot access the capital. As with any annuity, you are giving up liquidity in exchange for certainty.
The Advanced Life Deferred Annuity. The retirement income option that you have never heard of. They are not going to solve every financial planning problem. But they could be a brilliant fit in the right circumstances.
Brad Brain. CFP, R.F.P., CIM, TEP is a Certified Financial Planner in Fort St John, BC. This material is prepared for general circulation and may not reflect your individual financial circumstances. Brad can be reached at www.bradbrainfinancial.com.
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