Your Retirement Income Blueprint provides a few alternatives to investing in GICs for preservation of capital while producing income. Author Daryl Diamond says GICs do have their place as investments, but given current rates of return, retirees with larger chunks of non-registered income -- those outside of RRSP and TFSAs -- should examine these options:
Corporate-class mutual funds: If you have non-registered money, corporate-class mutual funds are a good option because they're designed with tax efficiency in mind. Basically, they're structured like a corporation, containing a variety of investment choices. The fund company can manage earnings and losses within this structure in a tax-efficient manner so distributions to investors result in as little tax as possible. Corporate-class funds also allow investors to move from one investment strategy (domestic equity, for example) to another (U.S. equity) without triggering taxes. Effectively, they offer the same tax sheltering as RRSPs.
Corporate-class funds can also provide tax-efficient, regular income because payments are considered capital gains, of which only 50 per cent are taxable. This contrasts with GIC interest income, which is fully taxable. They can also be set up to provide income payments from the invested capital, which isn't taxable.
Life annuities: Most people are aware they can turn over a chunk of their capital to an insurance firm in exchange for a guaranteed revenue stream for life. Called a life annuity, Diamond says it can be one effective cash-flow stream of many to provide a secure income for retirees.
Life annuities can actually be a good guaranteed income stream for retirees in their late 70s or early 80s, too. The reason for this is mortality credits, he says. Basically, these are how insurance companies assess annuitants' life expectancy. The less time the insurer thinks you will live, the greater the annuity payment will be.
Diamond says designating a portion of retirement capital later in life to an annuity can act as a hedge against longevity risk, providing an annuitant a guaranteed payment that potentially exceeds returns found in financial markets over the same time period.
Prescribed taxation annuities: Annuities can be a tax-efficient way for a portion of non-registered assets to provide income because they receive prescribed taxation treatment. Under normal circumstances early on, the annuity payment would mostly consist of interest, which is fully taxable and later on, the payments would consist of mostly a return on capital, which isn't taxable. But prescribed annuities provide a blended payment of interest and capital over the entire life of the annuitant, providing a steady source of income that is tax-efficient in early years.
Tax-deferred annuity: This strategy involves buying an annuity with a portion of non-registered money and investing the rest in a corporate-class fund. The money in the fund grows mostly tax-sheltered, while the annuity provides income that is taxed more favourably than interest income from a GIC.
For example, $100,000 invested in a GIC at 3.5 per cent for two five-year terms would provide $2,415 in after-tax (at the 31 per cent marginal rate) annual income. That same $100,000, with $21,281 invested in an annuity for a 10-year term would provide the same annual income. The remainder, $78,719, could be invested in a corporate-class mutual fund that at the end of 10 years would grow to about $140,000 with an average annual return of six per cent. Even with a 2.83 per cent average annual return, the money would grow to $100,000 at the end of 10 years.
Insured annuity: Also called a back-to-back annuity, this strategy involves buying a life annuity, using a portion of the income it generates to pay for the premium on a life insurance policy, and then using the life insurance benefit to leave a non-taxable source of funds for the annuitant's estate upon death.
At a 31 per cent marginal rate, the annuitant's $200,000 investment in a joint life annuity -- depending on health -- would pay an annual net income of about $7,500. In contrast, a GIC paying 3.5 per cent would generate $4,900 net annually. Under normal circumstances, the annuity uses up all the capital, whereas a GIC would return the original investment. Yet, because a portion of the annuity-- $2,710 of the $11,242 gross annual income -- can go toward paying for life insurance with a $200,000 benefit, the capital that went toward purchasing the annuity would be replaced by the benefit upon death of the last survivor, providing tax-free money to the estate.
