Income Annuity – Is it right for you?

You’ve worked hard and saved for your retirement, and you want to protect your income. This forgotten gem has been overlooked for many years due to the past low-interest rate environment.  

An income annuity is a financial product that provides you with a guaranteed regular income. Typically, it is used during your retirement years and offered by an annuity provider, such as a life insurance company. When you buy an annuity, the insurance company will pay you, the annuitant, a regular income for a fixed term or the rest of your life, no matter how long you live – so you can expect regular, predictable, and stable income, no matter what happens to your other sources of income or the economy.

What’s great about an annuity is that it isn’t affected by financial market changes – the income payments from your annuity stay the same regardless of market performance or if interest rates change. Annuities can also give you access to cash if you apply the cashable feature. This can help you cover unexpected expenses. With this flexibility, you can be confident that your annuity can help supplement your income, in all stages of your retirement.

An annuity might be the right retirement income option for you if you’re:

• Near or in retirement.
• Concerned about outliving your money.
• Worried that poor-performing financial markets may reduce your retirement savings.
• Seeking a steady income stream to cover your basic expenses.
• In need of income until your Canada Pension Plan (CPP) or Quebec Pension Plan (QPP) and old age security (OAS) payments begin.
• Looking to convert your Registered Retirement Savings Plan (RRSP) funds into a regular income stream instead of using a Registered Retirement Income Fund (RRIF) option

Think of an annuity-like pension plan, which pools money from thousands of Canadians. You deposit the amount of money you’d like, and the insurance company in turn ensures you have stable, predictable income that’s guaranteed for a fixed term or for life, based on the annuity you choose. However, understand that generally, when you pass away your original investment is gone/forfeited to the insurance company. 

There is nothing to leave to your heirs.

You can buy an annuity with registered sources of money, such as an RRSP, also known as a registered annuity. You can also buy an annuity with non-registered sources of money. This is known as a non-registered annuity. How does it work?

1. They (the insurance companies) invest the money conservatively.
2. They use their expertise and data to estimate how many people in the group of Canadians are likely to live beyond the average life expectancy, and how many may not.
3. They guarantee your income for a fixed term or life, based on their conservative investments and variability in life spans. They are betting you pass away before the date as they keep the remaining capital and you are betting on exceeding the date and forcing them to pay longer.
4. People whose lives are shorter than average will collect less money overall, while people who live longer will enjoy more money overall.

Here’s an example of a Lifetime annuity income survey – female
Monthly income based on a premium of $100,000 registered funds and a 10-year guarantee

What options are available?

There are lots of options you can get with your annuity, based on your needs, the type of annuity you choose, and the details of your contract.

If it is important for you to leave a legacy, you can choose one or more of the following annuity options. Note that every option you add reduces the income payment you will receive.

1. Guaranteed income payment option (guaranteed period) which provides income payments for a specific period (e.g., 5 or 10 years), even if you or you and your joint annuitant die:

• If you die before the guaranteed period ends, your beneficiary can receive a lump-sum payment equal to the present value of all remaining guaranteed payments.  

• If the beneficiary is a spouse, they can choose to receive the remaining income payments until the end of the guaranteed period. When that spouse passes away, and the guarantee period has ended, the payments end, and the remaining capital is retained by the insurance company.

2. Return of premium options: If you pass away your beneficiary receives the initial purchase amount.

• If the last annuitant dies before any income payments were made from the annuity, your beneficiary will receive either a lump-sum death benefit equals to the initial purchase amount of the annuity with or without interest.

• If the last annuitant dies after income payments began, depending on the feature that was selected, the beneficiary will receive either a one-time payment that’s equal to the initial purchase amount minus the income payments already received or continuing income payments until the total initial purchase amount is returned.

3.   Indexing option:

• protect your retirement income from the effects of inflation with the annual payment increase (indexing) option, you can choose to have your income payments increase at a fixed annual rate.

Other types of annuities include:

1. Single-life annuity is like a pension plan for one person. It is a lifetime annuity that gives you stable and regular income payments for life.
2. Joint Annuity is like a pension plan for a couple. It gives you stable regular income payments for as long as you or your spouse lives. When one spouse dies, the survivor continues to receive income payments.
3. Term certain annuity which gives you stable and regular income payments for a fixed term, instead of for life.

If you choose a non-registered annuity, you may choose the prescribed taxation option, the taxable amount of each income payment from your annuity will stay the same. This is also known as level taxation, and this leveling out of taxable income payments means you will receive more after-tax income within your early income payments. This option is only available if your non-registered annuity qualifies and is subject to legislative restrictions.

To get a larger taxable income in the early years of your retirement you can use accrual taxation, the opposite of prescribed taxation. Accrual taxation means that there’s a larger taxable income in the initial years of your payments that declines over time. This type of taxation is the default if you don’t qualify for prescribed taxation.  

Using your non-registered capital to purchase a life annuity will produce a higher income, especially with a shorter guarantee period than typical publicly traded fixed-income investments (bonds), and ensures a guaranteed income that you can’t outlive. Each income payment from a life annuity is a blend of interest and your original capital, where only the interest portion is taxable. As stated above, annuities generally die with the policyholder. There is no residual money paid out to your estate as with a RRIF or non-registered brokerage account. However, you can set up an “insured annuity” whose income stream pays both you and the premium on a life insurance policy. When you die the annuity payments stop and the life insurance benefit is paid to your beneficiaries.  

Purchasing an annuity is among the safest options for long-term financial planning but like all options, they are not for everyone. They are insurance products, so once contracted you are committed to the end. While they experience less volatility than counterparts participating in financial markets, they may also not perform as well over time. Some annuity types have higher risks — and higher potential rewards than others. For more information, please contact your advisor.

Written By: Shawn Ryan