The growing guaranteed retirement market
Canada’s banks and insurance companies square off in fight to decide who should provide aging boomers with ‘guaranteed’ retirement income.
If you can see retirement looming, keep an eye on the turf war that's heating up between the Bank of Montreal and the country's life insurance industry.
Some of the biggest life insurers have been lobbying the Office of the Superintendent of Financial Institutions to review a relatively new product called BMO Lifetime Cash Flow, through which the bank provides clients aged 55 and over with a predictable source of income for life.
At issue is whether the resulting contract is really an annuity, an insurance product that banks aren't allowed to offer under existing regulations. Were BMO's product to thrive (and the remaining big four would surely follow) it would give the banks a sizeable advantage over insurers, the industry argues.
That's because BMO or any future players don't have to come up with the same capital and reserve requirements as insurers which issue annuities are forced to do.
And the potential liabilities can be huge. When markets collapsed in 2008, Manulife's capital levels, usually well above the minimum level set by the regulators, dropped sharply because of the massive stock portfolio associated with annuity contracts marketed under its popular Income Plus banner.
Manulife, under OSFI's urging, addressed this issue some time ago, of course. But, under similar circumstances in the future, BMO wouldn't be subject to the same set of rules.
Even though there seems to be little reason to doubt BMO's ability to settle up down the road, its guarantee isn't backed up by specific capital requirements as insurance-based products are required to be - nor are Lifetime Cash Flow deposits insured by Canada Deposit Insurance Corporation.
The insurers' worry is that, without these formal reserves, a bank could afford to charge customers less for similar products, thus obtaining an unfair edge and stealing market share.
Why should you care? Well, since cynics argue that the financial industry's main purpose is to convert capital and income into fees and expenses, more competition might actually reduce prices a bit, which is always welcome change.
Make no mistake about it, the retirement income market is a key target for every financial institution. The prospect of a surefire income stream from retirement savings has gained massive appeal among investors and the demand is only going to increase.
In fact, a recent survey found that 90 per cent of Canadians believe it's important to have a guaranteed source of income during retirement beyond government pensions. Not surprising when you consider that more than half of respondents expressed real concern over having enough money to get them through life after work.
But is BMO's recent offering or any of the other "guaranteed income" products the secret to worry-free retirement? For some people, quite likely — but all the programs on the market come at a considerable cost.
Although not quite the same in structure as existing Guaranteed Minimum Withdrawal Benefit or GMWB plans offered by insurance companies like Manulife and Sun Life, BMO's offering works on the same principle — to provide you with longevity insurance and a predictable, guaranteed source of income from a portfolio of BMO funds that's rebalanced annually.
The program is really designed for those between ages 55 and 65, or at least ten years away from retirement, since your money is locked up for the first decade during which you won't see any payments whatsoever.
After that, BMO guarantees annual payments of six per cent of the original principal amount which continue as long as you're alive. On death, any remaining money would be transferred to your estate.
As a bonus, during the first 15 years of the contract any income you receive will be tax-free because it's actually a return of capital. From there though, the six per cent annual payout will be taxable as interest.
Whether it's existing GMWB offerings like Income Plus or this new variation, the issue is the same, though — you're paying for a guarantee on what's already a fairly conservative asset mix and facing corrosive fees that go on and on.
Since you never start out with 100 per cent equity exposure in any of these programs (BMO's portfolio starts out with 20 per cent in bonds, moving to 65 per cent over time), are the underlying expenses worth the peace of mind they seem to offer?
Certainly, to some, as there's been no shortage of buyers recently.
But one thing is clear. Don't be in too much of a hurry to commit too much to any one vendor. You're going to have a lot more choices when it comes to creating retirement income.
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