A new GRIP on retirement income*

The Guaranteed Retirement Income Plan (GRIP) can give retirees the peace of mind they won't find elsewhere in today's market 

*This is an expanded version of a summary that appeared in the November 2003 print edition of CAmagazine.

By David Hiscock

Retirees who have accumulated non-registered funds expect to generate a reasonable level of income, without risk of capital loss, to supplement their other sources of income.  However, in today's environment, this proves to be a difficult challenge. Equity markets are very volatile. Bond yields are historically low. And high taxation can substantially reduce return. But there is an approach that rises to this challenge: the Guaranteed Retirement Income Plan (GRIP). It offers:
• Guaranteed high yield before- and after-tax income payable for as long as one or both spouses live.
• Guaranteed return of principal, on death, tax and probate free.

The concept integrates two financial products — a life annuity and a life insurance policy — into one package. 

How it works
Phase 1: Setup
A lump sum amount of non-registered funds is used to acquire a life annuity.  An annuity converts a lump sum investment into a series of periodic fixed guaranteed payments that are payable for as long as the annuitant lives.  Each annuity payment consists of a return of a portion of the capital investment and interest income.

Annuities are flexible and can be structured as follows:
• Payment frequency — Choose monthly or annual payment.
• Guaranteed payment period — Choose a guaranteed  minimum number of payments regardless of how long the annuitant lives.
• Single or joint — Can be purchased so that payments are contingent on the life of one or both spouses.
• Level of payment after first annuitant dies — You can reduce the payment amount or keep it unchanged after the first spouse dies.

A life insurance policy on the lives of the annuitants for an amount equal to the capital invested in the annuity is also acquired. It is critically important that the underwriting of the life insurance be complete before the annuity is purchased. You need to know whether you can get the coverage (and at what cost) because once purchased, a life annuity is locked in for life.

Phase 2: Income generation
The setup of the two financial products creates the following income flow:
Gross annuity payment
Less cost of the life insurance premium
Less tax payable on the interest portion of the annuity
Equals net after-tax income
Marginal tax rate impacts net after- tax income that is earned as long as one or both spouses live.

Phase 3: Return of principal
After the annuitants have made use of their capital, tax-free life insurance proceeds are paid on their death.  If a beneficiary is named in the life insurance policy the proceeds also pass probate- free.
Examples
Assumptions
• Annuity investment: $1 million
• Annuity payment guarantee period: None
• Insurance amount: $1 million
• Premium and annuity payment frequency: Monthly
• Annuity payment reduction on first death: None
• Marginal tax rate: 46%
• Five-year GIC yield over the 10-year period ending June 30/01: 6.2%
• Underwriting risk class: Standard mortality for a non-smoker

Results and ROI comparison with GIC

Note:
1. Annuity rates are affected by prevailing interest rate, amount and timing of deposit; age and health condition of the annuitants.
2. Insurance premiums vary by plan, amount of coverage; age, sex, health and lifestyle factors.
3. Annuity and premium rates provided by OSI Worldwide Inc., which markets GRIP
4. Five-year GIC rate obtained from AndexChart for Canadian Investors.

Frequently asked questions
1. How much does it cots to set up the program?
There are no setup fees, since all underwriting costs are borne by the respective insurance companies.
2. What is the minimum required investment?
This varies according to the insurance company, but generally the minimum investment is $100,000.
3. What impact do changing interest rates have on the annuity payment and the insurance premium?
Once the products are bought the annuity payments and insurance premiums are fixed and guaranteed for life and do not fluctuate with interest rate changes.
4. If interest rates rise, can I cash my annuity and invest at the new higher rate?
The annuity is a locked-in investment and non-redeemable.
5. How do marginal income tax rates affect my net after-tax income from this program?
As marginal tax rates drop the amount of tax payable on the interest portion of the annuity also drops, resulting in an increase in the net after-tax payout. The reverse is also true.
6. How can I reduce my exposure to the risk of an insurance company becoming insolvent?

Perform your due diligence on the target companies. A proven risk-reducing strategy is to select financially strong companies as rated by S&P, Moody's or A.M. Best.  However, in the event of insolvency the Canadian Life and Health Insurance Compensation Corporation (CompCorp) protects Canadian policyholders by guaranteeing the payment of certain benefits up to set limits.

GRIP is an investment alternative that retirees with non-registered funds should consider.  It offers:
• Guaranteed stable high-yield income payable for as long as one or both spouses live.
• Substantially better after-tax return compared with commonly used GICs
• Guaranteed return of principal, tax and probate free
• Favourable tax treatment — Only the interest portion of the annuity payment is taxable.
• Flexibility — Investors can choose how much to invest and structure the payout to suit their needs
• Diversification of retirement portfolio — Allocating a portion of retirement funds to this concept can reduce portfolio risk and enhance return.
• Security and peace of mind — Returns do not fluctuate; they are guaranteed and backed by chosen financially strong Canadian insurance companies.

David Hiscock, B Math, CMA, CPA, CA is adjunct professor of accounting at the Michael DeGroote School of Business at McMaster University in Hamilton, Ontario. For more information on the subject covered in this article, you can reach him at hiscock@mcmaster.ca or 905-525-9140, ext. 26194.