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Not long ago the popular dream of retirement started at age 55, followed by many healthy years away from work enjoying hobbies, travel and time with family and friends. That picture of the future may have never been overly realistic from a financial perspective, and it has certainly changed over the years.

Today, 72 per cent of Canadians are seriously thinking about continuing to work after they officially retire, according to a recent Decima Research Inc. survey. They imagine themselves employed full-time, part-time or as consultants and business owners.

Why has the idea of a working retirement become so popular? In part, retirees are motivated by a desire to remain connected to the working world. More ominously though, many are worried that the money they've saved for retirement won't last long enough.

There's reason for concern. According to Statistics Canada, a 65-year-old man can expect to live another 16 years. A 65-year-old woman can expect to live nearly 20 years. And not all of that time will be healthy. Disability-free life expectancy for Canadian men is just 66.9 years. For women, it's not much better, at 70.2 years. As retirees' health deteriorates, they may need significantly more income to support modifications to their homes and, possibly, accommodation in a long-term care facility or other long-term care expenses.

Nevertheless, while fear of running out of money might be causing a majority of Canadians to consider softening the transition to retirement by remaining at work, few people approaching -- or at retirement age succeed in staying employed. Just 31.9 per cent of people over 55 and 9.7 per cent of people over 65 were in the labour force in 2006, says Statistics Canada.

That means the majority of older Canadians are not working. These individuals have to rely on the capital they have amassed, supplemented by income generated by their investments and government benefits, to support them throughout the rest of their lives.

Will your money last long enough?

Let's assume that you've retired at 65 with Canada Pension Plan benefits, along with Old Age Security benefits and a small pension from your employer. You've paid off your house and you don't have any other significant debt. You calculate that you need an additional $10,000 in inflation-adjusted after-tax income drawn from your investments to maintain your pre-retirement standard of living.

Fortunately, you inherited $300,000 from your parent's estate. How long will it last? That depends on a number of factors, including inflation, your marginal tax rate, and the average annual rate of return on your investments. Let's assume 3 per cent annual inflation, a 47 per cent tax rate and a 5 per cent rate of return from a mix of fixed-income and balanced mutual funds. Under these conditions, your nest egg will support you for a little more than 18.5 years.

That sounds like a long time. However, if you're a man, you have a 33.4 per cent chance of reaching the age of 85 and running out of money. If you're a woman, you have a 52.6 per cent possibility of reaching the same age and outliving your nest egg. Those aren't very good odds.

There are a few things you can do to make your money last longer. Earning a higher rate of return makes a significant difference. In fact, if you can achieve a 9 per cent rate of return every year, the growth in your investments will be sufficient to fully cover your withdrawals and your money will last to age 101. But as we all know, earning a sustained 9 per cent annual rate of return is totally unrealistic -- even moreso when in the withdrawal stage of your financial life. It would require you to invest heavily in higher-risk equities that are much more volatile than your post-retirement risk tolerance will allow.

Protecting your income with an annuity

An option that is becoming increasingly more popular as retirees look to add certainty to their retirement income stream is the purchase an annuity. An annuity pays out a guaranteed income for life or for a specified period of time.

There are various types of annuities, but three of the most common are:

* Life annuities, which pay a set amount of income for life

* Term certain annuities, which pay a set amount of income for a time period you choose

* Insured annuities, whereby the original amount of capital invested in the annuity is recaptured upon the death of the annuitant, for the benefit of his or her heirs.

The above annuities can be indexed or not indexed. Life annuities can be on a single life, or on a joint-last survivor basis. As well, annuities can come with income guarantees for a specific number of years. Of course indexation and guarantees have an added cost, which is reflected in a reduced-income stream.

Non-registered annuities pay out a tax-advantaged income stream (referred as prescribed treatment for tax purposes). This is because when an annuity is purchased, the annuitant forever gives up his or her claim to the funds invested -- in exchange for a guaranteed income stream for the balance of his or her life (or joint lives, as the case may be). Thus, each annuity payment comprises a component deemed by the CRA as "return of capital" (i.e. return of one's own money) which is not taxable. The balance of the payment is taxed as interest income.

Of course the downside to an annuity is that the payments cease when the annuitant dies. So, if an annuitant invested $300,000 today, and received monthly income payments for two years and then died, the income stream would terminate, meaning a considerable portion of the $300,000 has essentially been forsaken. To guard against this risk, the annuitant would likely have purchased a partial guarantee to ensure at least all of his or her money was paid back, to the annuitant himself or herself, or to his or her successors. Alternatively, a joint-last annuity is common for couples, where they want to ensure that the income stream lasts as long as they do. Finally, in circumstances where the annuitant is insurable, an insured annuity returns the invested funds to the estate of the annuitant upon the annuitant's death.

So, what's so exciting about an annuity. Well, there are many retirees and pre-retirees out there whom are conservative investors and do not want any risk with all or a portion of their retirement (or other) funds. Consider that GIC's are currently paying very low rates, and are fully taxable. Let's look at an example: Fred is a 65 year-old retiree seeking a safe investment to provide stable returns throughout his retirement. Fred is a very good customer at his bank, and is offered a 5-year GIC at 4 per cent. Fred understands that income from his GIC will be fully taxed at his marginal tax rate of 47 per cent, leaving him $6,360/year after tax. Fred is not excited by these numbers, and he is also concerned with where rates will go in future. What if they decline? Fred wants 100 per cent principal protection, but he also wants the best yield he can get.

Fred then asks his financial advisor for recommendations, based upon specific parameters, being that he wants 100 per cent income protection, with as high a yield as possible. Fred's advisor does his research, and presents Fred with the following options:

1. Fred can buy an annuity with his $300,000. The annuity will provide Fred with a guaranteed annual income of $24,832 (8.3% rate of return, before tax). Of this sum, Fred must include $7,490 in taxable income, meaning he will have to pay $3,520 in annual tax (at his 47 per cent marginal tax rate) -- leaving him $21,312 (7.1 per cent rate of return after tax). This beats the pants off the GIC after tax income of $6,380 (2.1 per cent rate of return after tax). Of course the downside to this scenario is that with the GIC, Fred retains access to the $300,000 as he is merely drawing interest income. With the annuity, Fred has given up his $300,000. If he lives long enough, he will reap the benefits, however this is a big risk in Fred's view. He prefers the 2nd option.

2. Fred can do exactly the same as Option 1, however he can add a $300,000 life insurance policy as an additional component -- so that when he dies, be it tomorrow or in 50 years, the $300,000 he invested in the annuity will come back to his estate as a tax-free benefit for his heirs. The annual cost for a $300,000 life insurance policy on Fred would be $9,177. This would reduce the above after-tax income from $21,312 to $12,135 ($21,312 - $9,177). After all is said and done, Fred is left with an annual income of $12,135 (4 per cent rate of return after tax) for life -- and when he dies his heirs will receive the $300,000 as a non-taxable life insurance death benefit. It is interesting to note that Fred is able to earn an after tax 4 per cent from the insured annuity, while with the GIC, the 4 per cent is before tax. In dollar terms, this represents a difference of $5,755/year in additional income -- almost twice as much spending power as the GIC produces. Fred would have to find a GIC paying 7.63% for the rest of his life to match the insured-annuity.

Annuities are provided by life insurance companies, and have become extremely popular in recent years due to the need for sustainable, predictable and guaranteed income by retirees -- and the need for higher yield than GIC's provide. Add an insurance policy to the mix and the result can sometimes be amazingly impressive.

If you're interested in finding out more about annuities or other income protection solutions, please do not hesitate to contact the writer. There are various options available that can help you enjoy retirement without worrying about whether you will outlast your money.