BMO Lifetime Cash Flow

Supposedly in response to calls from the (Canadian) federal government, this according to the Toronto Star, the Bank of Montreal is set to unveil this product today. Described as the first of its kind, this product is designed to give (Canadians) ages 55 and over a guaranteed cash flow, regardless of stock market fluctuations (again according to the Star).

The timing is impeccable for this launch as our finance minister, Mr. Flaherty is spearheading the debate over pension reforms. This same minister, also this morning, unequivocally stated that interest rates were  going to go up (soon) and added weight to that opinion by announcing more restrictive mortgage lending rules (30 years will be the max. amortization period etc. etc.)

So how does this product work? Well you deposit your $100,000 and for ten years you will earn,but not receive , the return from  a  group of mutual funds managed to be sensitive to your life-cycle (i.e more conservative as you get older). This is done in such a way that no taxes are payable during this “accumulation”  period. After that you will get 6% on the original amount for a period of 15 years which income is considered return of capital and therefore not taxable.  After that you continue to receive 6% but now taxable and this goes on forever, that is to when you die. The remainder, if any, will be transferred to your estate and would be taxable.

So why should you NOT buy this? Simple arithmetic. If you wanted a guaranteed cash-flow you could buy a 30 year (more on this later) Gov. of Canada bond yielding 3.69% (the could do this as a base case). As the MER on this instrument is 2.75% you would accumulate 3.69-2.75=0.94% per annum compounded for 10 years that gives you $109,810. From there you will receive 6% (on the original amount of $100,000 ) which is equal to 5.56% on the accumulated amount. As you are still earning 0.94%, but receiving 6% , your fund depletes at 5.06% per annum, which, over 15 years leaves you with $50,394. By now you are 55+10+15=80 years old.

At age 55 your life expectancy as a male is 79.33 years and as a female 82.81. Lets assume that you are not sure anymore what you are at these ages, and use the average of 81,07 and for the sake of simplicity lets just call that 81 years. You may have been worried about growing very old and running out of money, but the BMO does not need to worry about that as this product will be sold to thousands of people and the average of the mortality tables will apply quite precisely.From their perspective you will die in one more year so they will pay another $6000 and earn about $500 in interest leaving roughly 50,394-5500=44894 in the account for your estate.

So what is the score? You the client gets 16 years at $6000 a year plus $44,894 to your estate for a total of $140,894. The BMO gets 2.75% MER per annum  (assuming on the original amount) for 26 years, or $71,500. What is there not to like?

I have used the 30-year Gov . bond as a proxy for the riskless investment nearest to the time frame we are looking at. Of course our client could do much better if the funds were very well invested etc. etc. but we are looking at the base case, ie what the BMO could do not to run any risk, which might well be the position they would want to gravitate to as much as possible being a bank.

Buying an annuity (last-to die for couples) would, if things stay the same,  pay about $520/month or $6240 a year. If a proscribed annuity is used ( the funds for the BMO product should come from non-tax deferred sources anyway!) the tax treatment overall may be better. And if Mr. Flaherty is correct, rates will be much higher 10 years from now. Furthermore annuity payments are considered the equivalent of a pension and are consequently eligible for both income splitting and the $2000 tax credit per person. It is not clear that this product offers the same advantages.