Retirement in a Time of (Still) Rising Interest Rates
Simon Barcelon
.15 Oct 2023
.After a year of decades-high inflation, investors in or nearing retirement have had to navigate the usual challenge of figuring out what investments work best for their retirement portfolio in an unprecedented economic environment and rising interest rates and inflation.
A series of interest rate hikes by the Bank of Canada to quell rising inflation have taken interest rates up to 5.0% in October 2023, from 1.0% where they stood in April 20221. As a result, yields offered on secure savings accounts, GICs and life annuities have also increased considerably, and these products have regained attention. Yet, as risk-free interest rates have increased, so too has the expected return on a balanced portfolio of stocks and bonds. This might create more attractive choices for investors who need financial flexibility and can tolerate some volatility when considering retirement planning. That’s where solutions come in, like the Longevity Pension Fund, which offers lifetime retirement income in ways similar to a life annuity within a more flexible mutual fund structure.
In this article, we’ll dig into the differences between life annuities and the Longevity Pension Fund and discuss the benefits and downsides of each to help decide what might make more sense for your retirement plan.
Key Takeaways:
With core interest rates increasing to 5% in the past year, the yields on GICs and annuities have also increased considerably, making these types of securities much more attractive investments.
Since rates have increased, the expected returns on a balanced portfolio has also risen. So, there’s a lot to be excited about for investors seeking to generate income in retirement.
The Longevity Pension Fund is an actively managed balanced portfolio that has also benefitted from the rising interest rates.
Investors in Longevity can expect, on average, 32% more income over their lifespan than they would receive from a life annuity.
Life Annuities and the Longevity Pension Fund
Although life annuities and the Longevity Pension Fund both offer income for life in retirement, how they do this is quite different.
First, let’s compare the key structural differences between a lifetime annuity with a 10-year guarantee period (the most common) and Longevity Pension Fund:
As you can see, while both products provide lifetime income in a retirement plan, yearly returns on Longevity are expected to rise over time, while the guaranteed income from life annuities remains constant.
Deep-Dive Analysis: Looking Long Term
Let’s dive in deeper to review the expected lifetime cash flows from each of these products.
Assumptions:
A 65-year-old with a $100,000 initial investment,
The average rate for a 65-year-old Canadian male and female investing in a life annuity with a 10-year guarantee period is 6.47%2.
The current yield for 65-year-olds investing in the Longevity Pension Fund is 7.16%3. The expected adjustments in Longevity’s distribution rate follow the average path of the Fund’s Income Policy under LifeWorks’ Economic Scenario Generator (“ESG”) data as of September 30, 2022.
Assumed life expectancy tables used by Canadian pension plans4.
Results:
Figure 1 - Annual income
This chart models hypothetical performance data. It was created using LifeWorks ESG data as of September 30, 2022, which includes 2,000 stochastically generated future economic scenarios. The results shown are purely hypothetical and do not provide a guarantee of the expected performance of the Fund. This chart does not consider all risks, fees, unique financial circumstances, or the costs of redeeming an investment in the Fund.
Figure 1 shows that the life annuity provides a guaranteed retirement income level of $6,471 per year, irrespective of market returns. The payments from the Longevity Pension Fund would start at $7,160 and are designed to increase over time; however, they can fluctuate on an annual basis depending on market returns and the experienced mortality of the cohort.
Figure 2 - Total returns (income payments + any residual value paid at death)
This chart models hypothetical performance data. It was created using LifeWorks ESG data as of September 30, 2022, which includes 2,000 stochastically generated future economic scenarios. The results shown are purely hypothetical and do not provide a guarantee of the expected performance of the Fund. This chart does not consider all risks, fees, unique financial circumstances, or the costs of redeeming an investment in the Fund.
Figure 2 shows total returns calculated as cumulative distributions received to date plus any residual value paid at death. In the event of early death with the life annuity, the investor’s estate would be entitled to the remaining payments until the 10-year guarantee period is over, making the minimum expected payout equal to $64,710 . In the event of early death with the Longevity Pension Fund, his or her estate would receive the unpaid capital (up to a maximum of current NAV), making the minimum expected payout in this example is equal to $100,000. In both cases, the investor will not receive anything at death once they have surpassed this threshold.
It becomes clear from the two charts above that although the level of income is not guaranteed, the Longevity Pension Fund provides a higher expected level of income when compared to life annuities. We can then examine the total lifetime income expected from each of these products by factoring in the investor’s expected mortality – i.e., what is the chance that each payment is actually received?
Appendix 1 includes the probability of being alive at various ages for the 65-year-old investor. By weighting these probabilities against the expected cash flow from each product, we can see in Figure 3 that the life annuity provides a total expected cash flow of $153,962.43 while Longevity provides $203,677.80. The Longevity Pension Fund provides $49,715 (or 32%) more in expected cash flows vs. that of the average life annuity available today.
Figure 3 - Total expected cash flow from annuity vs Longevity
This chart models hypothetical performance data. It was created using LifeWorks ESG data as of September 30, 2022, which includes 2,000 stochastically generated future economic scenarios. The results shown are purely hypothetical and do not provide a guarantee of the expected performance of the Fund. This chart does not consider all risks, fees, unique financial circumstances, or the costs of redeeming an investment in the Fund.
Overall, while life annuities are excellent products for those requiring complete certainty, their guarantees come at a cost. The same economic forces that are raising the fixed payments that life annuities offer are raising the variable payments that Longevity Pension Fund is expected to make.
In keeping with core financial principles, investors can expect more income over their lifetime on average from Longevity. This is similar to how an investor who accepts some volatility in a balanced portfolio of stocks and bonds can expect to earn more, on average, than an investor in a secure interest-bearing account.
To learn more about how the Longevity Pension Fund can streamline your portfolio management and help your clients, reach out to your Purpose Investments sales representative, give us a call directly at 1-888-273-8471 or email us at contact@retirewithlongevity.com.
Appendix 1: Expected cash flow factoring in mortality rates
This chart models hypothetical performance data. It was created using LifeWorks ESG data as of September 30, 2022, which includes 2,000 stochastically generated future economic scenarios. The results shown are purely hypothetical and do not provide a guarantee of the expected performance of the Fund. This chart does not consider all risks, fees, unique financial circumstances, or the costs of redeeming an investment in the Fund.
bankofcanada.ca/core-functions/monetary-policy/key-interest-rate/
Taken from Sunlife.ca, as of October 2, 2023. Quote is for a single life, 10-year-guarantee and premium of $100,000 of registered assets. Average between a 65-year-old male and female.
Current yield for LPF is as of October 2, 2023. Income in the form of Fund distributions is not guaranteed, and the frequency and amount of distributions may increase or decrease. The Fund has a unique mutual fund structure. Most mutual funds redeem at their associated Net Asset Value (NAV). In contrast, redemptions in the decumulation class of the Fund (whether voluntary or at death) will occur at the lesser of NAV or the initial investment amount less any distributions received.
The mortality table follows the blended average of males and females within the CPM2014 public sector rates taken forward to 2023 using the MI2017 mortality improvement scale (to account for increasing life expectancy).
Commissions, trailing commissions, management fees and expenses all may be associated with investment fund investments. The prospectus contains important detailed information about the investment fund. Please read the prospectus before investing. There is no assurance that any fund will achieve its investment objective, and its net asset value, yield, and investment return will fluctuate from time to time with market conditions. If the securities are purchased or sold on a stock exchange, you may pay more or receive less than the current net asset value. Investment funds are not guaranteed, their values change frequently, and past performance may not be repeated. Income in the form of Fund distributions is not guaranteed, and the frequency and amount of distributions may increase or decrease. The Fund has a unique mutual fund structure. Most mutual funds redeem at their associated Net Asset Value (NAV). In contrast, redemptions in the decumulation class of the Fund (whether voluntary or at death) will occur at the lesser of NAV or original purchase price less distributions paid.
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