Much like an adult diaper, if you’re planning on a traditional retirement strategy, the sh!t could very well hit the fan without one.
First things first
The word Annuity refers to a fixed amount of money that is paid to you on a regular basis, for a specific amount of time.
“Waaaaaaaaaaaait-a-second. But I’m paying money INTO my Retirement Annuity, it isn’t paying me anything.” And you’re right. As usual, the wonderful world of finance is as clear as mud. Like Chuck Norris and the wall that offended him, let’s break it down.
So here’s the one we’ve all heard of. In the land of Rugby World Cup Winners, we refer to an investment mechanism used by individuals to save for their grey days as a Retirement Annuity. For yearrrrrs and yearrrrrs you contribute some moola every month, and then when you get to 55, or later if you like, that money all starts coming back to you.
And this is the “how” part of how your money comes back to you. By law, when you get to retirement age, you can’t just take all your money out of your Retirement Annuity, fly to Vegas and blow it all on oily chicken wings and even oilier strippers. “But it’s MY money!” I hear you say. And technically you’re right. But the powers-that-be are trying to save us from being bamboozled by our new-found wealth, and choking to death on stripper dust.
According to the Income Tax Act, when you hit retirement age, you have to put at least two thirds of your retirement money into something called a Compulsory Annuity.
A Compulsory Annuity is an investment vehicle. Your money is reinvested in order to continue growing, and a fixed amount is paid to you for the rest of your life. That’s an important distinguishing feature of a Compulsory Annuity: It pays you a fixed amount of money until you die. Well isn’t this a cheerful topic.
This fixed amount, aka the annuity, is a bit like earning a salary. Obviously how big this salary is all depends on how much money you have accumulated and how long you need it to last.
So what happens if you die unexpectedly and there was still loads of your money left? Sit down for this bit – it’s going to suck: your money is forfeited and used to pay for other old fogeys who live longer than anyone expected. Ethel in Room 15B did f*ck tons of yoga. She’s going to be blowing her dentures across many more birthday cakes.
There are ways around this though. Without going into too much detail, you get options like a Joint-and-Last-Survivor option which keeps paying out your money to your spouse until they die. There’s also a Guaranteed Term option which keeps your money paying out for a certain time frame, even if you peg before that time is up. Or there’s a Capital Preservation option which, when you die, pays out the initial amount of money you invested when you retired.
There is a special type of Compulsory Annuity that is worth considering if you’re really concerned about Ethel using up all of your hard-earned money on bunion creams and denture glue. And that’s called a…
This type of Compulsory Annuity also keeps paying you until you die, except any money left over is paid to your beneficiaries. So why doesn’t everyone just sign up for a Living Annuity? Well, it’s not for the faint of heart or those of unsound mind – and by retirement age, you might battling both of those.
You see, with this type of annuity, YOU decide how to invest this money. At the ripe old age of eighty-plus, you’re thrust into the role of investor. And unless you really know what you’re doing, you could risk losing all your money if you made a bad investment decision into, say, bingo balls. You also decide how much money you want to withdraw every year, and if you’re hell-bent on the expensive bells-and-whistles wheelchair lifestyle, there’s a real danger you could run out of money. Basically a Living Annuity is only advisable for super-savvy silver surfers, or those with BUCKETS of money.
Lastly, there’s a thing called a Voluntary Annuity. Again, you invest money in, and then it pays you your money back in fixed amounts over a predetermined period of time. This type doesn’t keep paying you until you die. It only keeps paying out for the amount of years you decide on upfront. And this one isn’t necessarily linked to retirement at all, except that you’re NOT allowed to invest money from a pension fund or retirement fund into a Voluntary Annuity. The money invested into a Voluntary Annuity has to come from other sources, like an inheritance, or cash made from selling your stash of stripper poles.
As an example: if you and your chicken wings hit it big at the slots in Vegas, you could take your winnings, invest it into a Voluntary Annuity, and then have it pay you a “salary” for the next 50 years. Ka-ching!
So there you have it. Not too tricky, and for those of us with money invested in a pension or retirement fund, it’s good to know our options before we all start depending on those Depends.
– The Money Mom