In Search of Income: Life Annuities & Monthly Income Funds

For some investors, the title of this article might seem like one of those documentaries on the Discovery Channel where intrepid explorers travel in search of rare species rumoured to be near extinction. Certainly, GIC investors are getting that feeling now, with rates under 2% for all terms.

In times of low rates, we are challenged to think about what we define as “income”.

Questions to Consider About Monthly Income Funds

• Are you consuming the investment income you draw, or is it accumulating in your bank account when it is paid out?
• Do you expect to be consuming some of the capital of your investment – or want that option?
• Is passing on an investment portfolio – or at least some part of it – to heirs a non-negotiable part of your estate plan?

The answers to these questions – combined with your investor personality – will determine the “non-GIC” monthly income options that could be considered.

Life Annuities

Depending on your age, a life annuity can make sense if the amount of income paid must be guaranteed, even in today’s low rates.

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Before writing this article, I took a life annuity quote from one of Canada’s major insurers for a 70-year-old female, funded with $100,000 in non-registered money. The insurer was quoting a monthly payment of $470.21, which annualizes to $5,642.52. Five years of payments would be guaranteed, meaning that if the person purchasing the annuity were to pass away before the expiry of the 5 years, their beneficiaries would receive the remainder of the guaranteed payments. If the purchaser lives past 5 years, they continue to receive their payments for life – but there would be no payout for beneficiaries.

The payment described in the annuity above would be equivalent to making 5.6% on a GIC. A life annuity is most assuredly not a GIC as there is no turning away from a life annuity once it is set up. You give up control of the capital used to purchase the annuity to have guaranteed payments for life.

When life annuities are purchased with non-registered money (as opposed to money from an RSP or RIF), the payments are quite tax-efficient, because only the portion of the payment deemed to be income is taxable, as opposed to the repayment of capital. The annuity quote above was a “prescribed” annuity – which fixes the taxable portion of the annuity payments for life. In this case, the annual income amount subject to tax was $148 – and no, that is not a typo!

Monthly Income Funds

It is also possible to generate attractive monthly income funds using mutual funds. Several mutual fund companies offer balanced fund products where a monthly distribution is paid. This distribution can be accumulated into the investment or be paid out to a bank account. There are some such funds available at present where the monthly distribution equates to a yield between 3% and 6% of the fund’s current unit price. With this approach – unlike the life annuity – you are not relinquishing control of the capital invested.

The value of the capital will fluctuate: no mutual fund has a guaranteed price, but it bears mentioning that the only way a mutual fund can have no value is if all of the securities it invests in have themselves lost all value.

There are essentially two approaches to monthly income funds with mutual funds.

Mutual Fund Option 1

The first approach is when the fund company sets the distribution amount based on the income being earned from investments – both at present and anticipated for the future. In this method, while the fund company can change the distribution amount at any time, they do not have to if they feel that future income can sustain the current payment.

Mutual Fund Option 2

In the second approach, a fund company will set the distribution for the coming year at a percentage of the fund’s unit price at the end of the current year. For example: suppose that a fund’s unit price on December 31, 2020 was $10.00 per unit, and the fund is paying a 6% distribution. The distribution for the following year will be $0.60 per unit for the full year or $0.05 per unit per month. In this approach, the monthly payment will change from one year to the next.

Consider the period from 2017 to 2020: the payment from such a fund in 2018 would likely have been higher than in 2017 because equity markets rose during 2017. By contrast, equity markets fell in 2018, and so the 2019 payment would have been lower. 2019 was a strong year for stocks, and so the payments being received in 2020 would be higher than in 2019.

In the two mutual fund options described above, it will be important to have some flexibility in your income plan to be able to absorb decreases in the distribution should that be required.            

If you have gaps in your income planning, considering these monthly income options could improve your cash flow provided they align with your circumstances, investor personality, and estate planning needs. How to make sure of this? A discussion with your Scrivens advisor about monthly income funds is the first step.