The hype of RRSP season may be over for another year, but retirement income remains top of mind for many. That includes the financial-services providers focused on wooing the wave of Canadians who are on the doorstep of retirement and worried about having enough.
Among the latest innovations to target Canadians who want guaranteed lifetime payouts and downside protection is BMO Lifetime Cash Flow, launched by BMO Financial Group in January. "One of the concerns that popped up increasingly in our research over the past three or four years is retirement income," says BMO vice- president Caroline Dabu, who is head of retirement planning and financial strategy.
The BMO Lifetime Cash Flow deposit note speaks specifically to our diminished access to one traditional guaranteed income source, according to Dabu. "We wanted to develop a product that would give Canadians a way to create their own pensions," she says, noting that only 30% of Canadians have workplace pension plans.
Although it's the first of its kind among deposit-takers, technically, BMO Lifetime Cash Flow is a principal protected note (PPN). This is a deposit instrument that has been around for years. PPNs guarantee the principal investment and potentially higher returns tied to specific underlying investments. In the case of BMO's Lifetime Cash Flow deposit note, returns are linked to a portfolio of BMO mutual funds.
In fact, says Dabu, BMO Lifetime Cash Flow operates exactly like a target-date mutual fund, shifting asset allocation toward a more conservative mix as the investor gets closer to retirement.
You must be at least 55 years old to invest in the BMO notes. For the first 10 years of the investment -- what BMO terms the "accumulation phase" -- you won't have access to your money. "You have to think about this as your own personal pension. When you have a pension, you can't touch it," says Dabu. "It is money you are specifically setting aside to create a guaranteed income stream."
Depending on one's personal situation, this lack of liquidity can be problematic. The product is unsuitable, for example, if you have little or no access to other funds to cover unforeseen needs. For this reason, Dabu says, it's recommended for only a portion of an individual's portfolio.
After 10 years, the depositor starts receiving cash payments equal to 6% per year, payable monthly and based on the initial deposit. These guaranteed payments continue for 15 years and, since they represent repayment of your initial deposit, they are not taxable.
This form of income may also be significant for those receiving government benefits. "Because it's return of capital, it doesn't affect OAS or GIS," says Dabu. Old Age Security benefits are paid to Canadians 65 and older, while the Guaranteed Income Supplement tops up OAS benefits for low-income seniors. Both programs are means-tested, so the level of benefits is tied to the recipient's income level.
After 15 years, the depositor continues to receive annual income equal to 6% of the initial deposit. In this phase, there are no restrictions on withdrawals, but now the income is in the form of taxable interest.
BMO's Lifetime Cash Flow note echoes -- with important differences -- two existing products offered by insurance companies. One of them is life annuities.
A long-time staple of risk-averse Canadians, annuities guarantee regular, set-rate payouts over the lifetime of the buyer or the lifetime of his or her spouse.
BMO's offering proposes to meet this need for stability while addressing a feature of annuities that many find bothersome: the fact that you permanently lose access to your capital, including giving up the ability to leave any residual value to your heirs.
By contrast, if you die holding the Lifetime Cash Flow product it can go to your estate or beneficiary, says BMO's Dabu. "If your beneficiary is at least 55 years of age, he or she can continue to hold the product and receive the income payments, or they can cash out the portfolio value."
Secondly, an even closer relative of the new deposit notes are guaranteed minimum withdrawal benefits (GMWBs). These are an optional feature of some insurance-company segregated funds. GMWBs were introduced in Canada by Manulife Financial in 2006. Today, these policies are offered by most major insurers and have grown to more than $20 billion in assets.
Although the terms may vary from issuer to issuer, GMWBs are similar to the BMO Lifetime Cash Flow deposit notes, in that they guarantee set payouts over the buyer's lifetime, even if markets decline. Generally starting at around 5%, withdrawal rates on GMWB contracts are also comparable to the 6% annual payout on the BMO deposit note.
However, GMWBs are insurance products. As such, they offer the benefits of segregated funds. These benefits include maturity guarantees, death benefits and the potential for creditor protection. Furthermore, GMWBs give buyers the potential to boost the guaranteed payments by delaying the start date of their withdrawals.
GMWB holders may also lock in market gains through reset provisions that could increase the guaranteed withdrawal amounts. For example, locking in gains on a $100,000 portfolio that grows to, say, $125,000 would raise the 5% annual income to $6,250 from $5,000. Resets typically take place every three years.
Not surprisingly, these extras are reflected in costs. With a GMWB you pay a charge for the base product, on top of the management-expense costs of the underlying funds that make up the contract. Even with the fewest number of options, costs for GMWBs are likely to run considerably higher than the 2.75% charged annually by BMO for its no-frills take on guaranteed retirement income.
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