
Generating income
When building retirement income strategies for your clients, keep in mind how certain product features can address your clients’ needs and concerns, depending on their specific situation. The table below provides an overview of how each income product category is positioned to accommodate specific client goals.
Income solutions |
Sources of guaranteed lifetime income |
Sources of non-guaranteed lifetime income | |
---|---|---|---|
Investor retirement need/concern |
Guaranteed Minimum Withdrawal Benefit (GMWB)1 |
Mutual funds and traditional segregated fund contracts2 |
GIA3 |
Liquidity: Ability to withdraw additional money when needed4 |
High |
High |
High |
Guaranteed lifetime income provides guaranteed income for life |
Yes |
NO |
NO |
Product complexity: The need for ongoing investment decisions and/or the complexity of product features |
High |
Med |
Med |
Income flexibility: Choice of when to begin or defer taking income |
Med5 |
High |
Med |
Inflation protection: Features that can potentially help the investment keep pace with inflation |
Med |
High |
Low |
For illustration purposes only. This is a brief summary of various products and their features and benefits. Refer to product-specific materials for more details. The low, medium and high scoring is a qualitative ranking of each product’s ability to meet a specific need or concern when compared to the other products.
1 Exceeding the withdrawal thresholds may have a negative impact on
future income payments. Age restrictions and other conditions may apply.
2 Includes Systematic Withdrawal Plans (SWPs) from these categories.
3 GIA refers to insurance company Guaranteed Interest Accounts.
4 Fees may apply.
5 Some products may provide greater flexibility.
Did you know?
Manulife now offers three investment products that combine the investment and insurance benefits of segregated funds and exchange traded funds (ETF). There are three single asset category Manulife Smart ETF-segregated funds, the first ETF segregated funds of their kind in Canada, currently available in both Manulife GIF Select InvestmentPlus and Manulife Private Investment Pools (MPIP) Segregated Pools. Speak to your wholesaler to learn more about these new products, and check out Manulifeim.ca/smart.
Earn continuing education credits; register for the new ETF segregated fund course available at Manulife’s Continuing Education Centre. Log in: Manulife.ca/advisors.
Did you know?
A GIA qualifies for deposit protection on investments up to $100,000. Assuris, which protects Canadian insurance policyholders, provides additional protection.
Risks and goals in retirement
With Canadians facing many challenges as they transition into retirement, the traditional financial planning and investment strategies such as asset allocation may no longer be enough to protect assets and ensure a sustainable retirement income stream, especially during volatile market conditions. Below are some of the potential risks that retirees may face.
Inflation risk
Inflation over the long term can significantly erode buying power. For example, in the table below you can see that in 30 years, the buying power would be reduced by nearly 60 per cent, assuming a 3 per cent inflation rate.
Effects of inflation on $1,000
Number of years | 0% ($) | 1% ($) | 2% ($) | 3% ($) | 4% ($) |
---|---|---|---|---|---|
1 |
1,000 |
990 |
980 |
970 |
962 |
10 |
1,000 |
905 |
820 |
739 |
676 |
20 |
1,000 |
820 |
673 |
545 |
456 |
30 |
1,000 |
742 |
552 |
402 |
308 |
Market volatility
During retirement, an investor’s rate of withdrawal and the order or sequence that they earn their market returns can have a dramatic impact on their portfolio’s ability to last. For example, if an investor experiences poor market returns early in retirement, this may have a dramatic impact on how much income they can continue to receive or how long it will last.
Longevity risk
Compared to previous generations, both male and female Canadians can expect to live longer lives and could spend as much time in retirement as they did working.
The probability of a healthy 65-year-old living until…
Age | Single female (%) | Single male (%) | At least one of a male and female couple who are the same age (%) |
---|---|---|---|
70 |
96 |
95 |
99 |
80 |
82 |
77 |
96 |
90 |
47 |
38 |
67 |
95 |
25 |
17 |
37 |
Source: 2012 IAM Basic ANB Tables, Society of Actuaries. For illustration purposes only.
Did you know?
You can now offer Guaranteed Interest Accounts (GIAs) and the Daily Interest Account (DIA) to your clients within GIF Select InvestmentPlus and MPIP Segregated Pools.
Faced with market volatility, investors are looking for both reassurance and flexibility. Offering GIA's and the DIA will allow your clients more options to diversify their portfolios while managing risk.
Why the sequence of returns matters
Sequence of returns means the risk of receiving lower or negative returns early in a period when withdrawals are made from the underlying investments. The order or the sequence of investment returns is a primary concern for those individuals who are retired and living off the income and capital of their investments.
During the accumulation phase, regardless of whether a portfolio experiences poor or strong returns early on, the market value will be the same in the end.
Accumulation phase
Starting value for Portfolio A and Portfolio B = $200,000 Annual income withdrawal = None
|
Portfolio A Poor early returns |
Portfolio B Strong early returns | ||
---|---|---|---|---|
Age |
Annual return (%) |
Year-end value ($) |
Annual return (%) |
Year-end value ($) |
40 |
– |
200,000 |
– |
200,000 |
41 |
-5.3 |
189,400 |
15.3 |
230,600 |
42 |
-2.1 |
185,423 |
-3.7 |
222,068 |
43 |
-7.3 |
171,887 |
14.0 |
253,157 |
44 |
-15.2 |
145,760 |
8.9 |
275,688 |
45 |
9.4 |
159,461 |
16.0 |
319,798 |
46 |
2.7 |
163,767 |
15.2 |
368,408 |
47 |
10.6 |
181,126 |
16.2 |
428,090 |
48 |
-9.8 |
163,376 |
13.5 |
485,882 |
49 |
-8.0 |
150,306 |
0.4 |
487,825 |
50 |
10.2 |
165,637 |
12.9 |
550,755 |
51 |
6.9 |
177,066 |
13.4 |
624,556 |
52 |
-5.5 |
167,327 |
9.5 |
683,889 |
53 |
2.1 |
170,841 |
13.5 |
776,214 |
54 |
2.4 |
174,941 |
6.0 |
822,787 |
55 |
9.2 |
191,036 |
-1.5 |
810,445 |
56 |
-1.5 |
188,170 |
9.2 |
885,006 |
57 |
6.0 |
199,461 |
2.4 |
906,246 |
58 |
13.5 |
226,388 |
2.1 |
925,277 |
59 |
9.5 |
247,895 |
-5.5 |
874,387 |
60 |
13.4 |
281,112 |
6.9 |
934,720 |
61 |
12.9 |
317,376 |
10.2 |
1,030,061 |
62 |
0.4 |
318,645 |
-8.0 |
947,656 |
63 |
13.5 |
361,663 |
-9.8 |
854,786 |
64 |
16.2 |
420,252 |
10.6 |
945,393 |
65 |
15.2 |
484,130 |
2.7 |
970,919 |
66 |
16.0 |
561,591 |
9.4 |
1,062,185 |
67 |
8.9 |
611,573 |
-15.2 |
900,733 |
68 |
14.0 |
697,193 |
-7.3 |
834,980 |
69 |
-3.7 |
671,397 |
-2.1 |
817,445 |
70 |
15.3 |
774,120 |
-5.3 |
774,120 |
Avg. |
4.6 |
774,120 |
4.6 |
774,120 |
|
|
No Difference |
A portfolio that experiences poor early returns can run out of money during retirement, whereas a portfolio experiencing strong early returns can last for many more years and maintain a high market value. This illustrates how the Sequence of Returns in those crucial first years can produce two very different outcomes.
In the chart below we look at two portfolios. Portfolio A has poor early returns and runs out of money within 17 years. Portfolio B experiences strong early returns, has 13 more years of withdrawals and still has a positive market value at age 95.
Retirement phase
Starting value for Portfolio A and Portfolio B = $500,000 Annual income withdrawals = $20,000 (4% of first-year value) adjusted thereafter for inflation. Inflation rate = 3%
|
Portfolio A Poor early returns |
Portfolio B Strong early returns | ||||
---|---|---|---|---|---|---|
Age |
Annual return (%) |
Withdrawal ($) |
Year-end value ($) |
Annual return (%) |
Withdrawal ($) |
Year-end value ($) |
65 |
– |
– |
500,000 |
– |
– |
500,000 |
66 |
-5.3 |
20,000 |
454,560 |
15.3 |
20,000 |
553,440 |
67 |
-2.1 |
20,600 |
424,847 |
-3.7 |
20,600 |
513,125 |
68 |
-7.3 |
21,218 |
374,164 |
14.0 |
21,218 |
560,774 |
69 |
-15.2 |
21,855 |
298,758 |
8.9 |
21,855 |
586,883 |
70 |
9.4 |
22,510 |
302,216 |
16.0 |
22,510 |
654,673 |
▼ |
▼ |
▼ | ||||
80 |
9.2 |
30,252 |
58,386 |
-1.5 |
30,252 |
1,245,891 |
81 |
-1.5 |
31,159 |
26,818 |
9.2 |
31,159 |
1,326,487 |
82 |
6.0 |
26,818 |
0 |
2.4 |
32,094 |
1,325,458 |
83 |
13.5 |
0 |
0 |
2.1 |
33,057 |
1,319,542 |
84 |
9.5 |
0 |
0 |
-5.5 |
34,049 |
1,214,791 |
85 |
13.4 |
0 |
0 |
6.9 |
35,070 |
1,261,122 |
▼ |
▼ |
▼ | ||||
90 |
15.2 |
0 |
0 |
2.7 |
40,656 |
1,111,520 |
91 |
16.0 |
0 |
0 |
9.4 |
41,876 |
1,170,191 |
92 |
8.9 |
0 |
0 |
-15.2 |
43,132 |
955,746 |
93 |
14.0 |
0 |
0 |
-7.3 |
44,426 |
844,794 |
94 |
-3.7 |
0 |
0 |
-2.1 |
45,759 |
782,256 |
95 |
15.3 |
0 |
0 |
-5.3 |
47,131 |
696,163 |
Avg. |
4.6 |
429,956 |
0 |
4.6 |
951,508 |
696,163 |
|
|
|
Big Difference | |||
Total income generated by portfolio during retirement = | $429,956 |
|
$951,508 |
| ||
Difference in withdrawals |
$521,552 | |||||
Difference in end value |
$696,163 | |||||
Total difference |
$1,217,715 |
For illustration purposes only. Returns for Portfolio A are hypothetical returns, and not indicative of future performance. It does not include any fees or Management Expense Ratios (MERs). For Portfolio B, the returns are reversed. The sequence of returns has an average compounded annualized return of 4.6 per cent over the respective periods. The accumulation portfolios assume a starting value of $200,000 at age 40 with no annual withdrawals. The retirement portfolios assume a starting value of $500,000 at age 65 as well as a four per cent first-year withdrawal, thereafter adjusted for three per cent inflation annually.
Cash wedge strategy
Market volatility can be both an investor’s friend and foe. For the long-term investor, a stumbling market presents an opportunity to buy stocks at reduced prices. But this doesn't work for an investor with immediate cash needs, such as retirees drawing an income. If the market drops early in their retirement, it can make a significant dent in their retirement income.
The cash wedge strategy is designed to help mitigate the impact of volatility on your client’s retirement income. It’s a way of organizing their wealth so that the assets they draw income from — a cash wedge representing one, two, or three years of income — is invested in stable-short term investments. The remaining money can be invested in funds selected to capture the growth potential that's associated with market-based investing, with any gains realized used to replenish their income source — your cash wedge.
How does the cash wedge strategy work?
Typical asset allocation for a balance-oriented investor
The cash wedge strategy works by taking advantage of the nature of various investment classes to help deliver predictable retirement income. It helps establish a “buy low/sell high” process that could result in higher returns, and also helps to avoid selling market-based securities at the wrong time. Your client remains in control, taking gains where and when appropriate.
The cash wedge: Keep one to three years of retirement income in a stable, accessible investment option that is less sensitive to market ups and downs. This is the cash wedge. The wedge should have minimal or no exposure to market volatility.
Fixed income: Keep another portion of your client’s portfolio in low volatility funds, to create another stable wedge to the portfolio. This will be used to replenish the cash wedge.
Equity: Invest in funds that match your client’s investor profile and can tap into the growth opportunities of the market. This portion of the portfolio is more focussed on growth, and any gains realized can be moved to replenish the other wedges in the portfolio.
Did you know?
GIAs have the potential to help with creditor protection during the investor’s lifetime, as well as after death when the death benefit passes directly to a named beneficiary outside the estate. It is very important to consult with a legal advisor to discuss the rules surrounding eligibility for creditor protection.
Tax treatment of investment income
Income from investments is included in taxable income at different rates. Active management of income-generating investments can significantly affect the way income is taxed and may help reduce clawbacks.
Chart 1: Consider the after-tax income on $10,000
Source of income | Inclusion rate (%) | Income reported on tax return ($) | Tax payable ($) | After-tax income ($) (MTR 40%) |
---|---|---|---|---|
Eligible dividends |
138 |
13,800 |
2,500 |
7,500 |
GIC/bond/RRIF/salary |
100 |
10,000 |
4,000 |
6,000 |
Capital gains |
50 |
5,000 |
2,000 |
8,000 |
Mutual/Segregated fund withdrawals |
2.5 |
250 |
100 |
9,900 |
Series T mutual fund |
0 |
– |
– |
10,000 |
The above chart illustrates how $10,000 of income, from different sources, is reported on a tax return and how much is remaining after tax.
Dividends
Dividends received from Canadian corporations receive preferential tax treatment through the application of the dividend tax credit. However, dividend income is the least income-friendly since only the grossed-up amount is reflected on the tax return, which is used to determine eligibility for many income-tested benefits such as Old Age Security (OAS). Dividends paid by public corporations qualify as ‘eligible dividends’ and are included at 138 per cent. Non-eligible dividends are included at 115 per cent. For illustration purposes, an effective tax rate of 25 per cent is assumed in the above chart – although it will vary by province.
Mutual/Segregated fund withdrawals
From an income-inclusion perspective, receiving income in this manner is income friendly since only a small portion of the income stream is taxable as a capital gain; the balance will be non-taxable Return of Capital (ROC). Chart 1 assumes $200,000 invested, five per cent annual rate of return ($10,000) and mutual/segregated fund withdrawals of $10,000. It represents results for year one and does not consider year-end distributions or allocations.
Series T mutual fund
Series T funds are a special class of mutual fund designed to help create a tax-efficient income stream from investments in non‑registered accounts, while allowing the deferral of capital gains taxes until a later point. ROC levels will fluctuate based on the level of income earned and distributed by the fund, as well as availability of the original capital. Illustration assumes 100 per cent ROC and no year-end distributions.
Note
For more information about tax topics like investment taxation visit the Tax Planning section in Viewpoints on the Manulife Investment Management website.
Withdrawal from investment funds – how to calculate the tax
At the time of each withdrawal, there is a sale of units to fund the withdrawal. This sale will trigger a capital gain or loss. To determine the amount of the capital gain or loss, one must look at the Adjusted Cost Base (ACB) and the growth/loss (Fair Market Value − ACB).
This diagram illustrates how to calculate the capital gain and the return of capital. In this example, the growth represents 1/21 ($10,000/$210,000) or 4.76% of the total Fair Market Value (FMV) and the return of capital represents 20/21 ($200,000/$210,000) or 95.24% of the FMV. Therefore, 1/21 (or 4.76 cents) of each dollar realized because of a redemption will be considered a capital gain (of which only 50% is taxable) and 20/21 (or 95.24 cents) of each dollar will be considered a return of capital (which is not taxable but reduces the ACB). The calculations will depend on the growth/loss and ACB at the time of withdrawal.
Guaranteed payment phase
For a product with a guaranteed lifetime income benefit, payments will continue when the FMV is $0 but there is a positive benefit base. The taxation of these payments is not certain at this time. Please consult your tax advisor for further information.