Annuities in Canada: Retirement Income Made Simple

Retirement can span decades yet research shows 60% of Canadians worry about outliving their savings. With pension plans declining and market volatility a constant threat, guaranteeing lifetime income is vital yet challenging.

This is where annuities in Canada can play a pivotal role. Annuities provide the security of income that cannot run dry, no matter how long you live.

Read on to learn how annuities work, weigh the pros and cons, and assess if integrating annuities into your retirement plan can help maximize certainty while avoiding the angst of unknown longevity.

What Are Annuities?

An annuity is a financial product offered by insurance companies that provides guaranteed income for a set period or for life in exchange for a lump-sum payment or a series of payments.

Annuities allow you to convert your retirement savings into a predictable stream of income. This can provide retirees with financial security, knowing they will receive steady payments regardless of market conditions and for as long as they need them.

How Do Annuities in Canada Work?

You purchase an annuity contract from an insurance company by paying a lump-sum premium or regular premium payments. In return, the insurer provides scheduled payments on a monthly, quarterly, semi-annual, or annual basis.

Payments can cover a specific term or last your entire lifetime. Lifetime annuity payments continue until death, even if this extends past life expectancy.

Annuities have two main phases:

Accumulation Phase

This is the period when you contribute premiums or a lump-sum payment to purchase the annuity product. You fund the annuity by making either:

• One lump-sum payment from your savings
• Smaller payments over time leading up to retirement

Annuitization Phase

This begins when the insurance company starts making regular income payments to you based on the details of your annuity contract. Annuity income payments can be made monthly, quarterly, semi-annually, or annually.

Once the annuitization phase starts, the insurance company will make regular payments to you for a fixed period or for life. These payments are generated from the funds you contributed, as well as potential investment growth in the case of deferred annuities.

Common Sources of Funds for Purchasing Annuities

There are six typical sources that individuals draw from when purchasing an annuity:

Registered Retirement Savings

Many use funds from Registered Retirement Savings Plans (RRSPs) or Registered Retirement Income Funds (RRIFs) to buy an annuity. These tax-deferred savings vehicles are designed to provide funds for retirement income.

Non-Registered Investments

Individuals may also use proceeds from non-registered investment accounts held outside RRSPs/RRIFs to purchase annuities. These could include stocks, bonds, mutual funds, and bank deposits.

Sale of Business or Property

Some annuity buyers may fund the purchase by selling a business, commercial real estate, or other valuable property before or upon retirement.

Inheritance

Receiving an inheritance of cash, investments, or property could provide a lump-sum windfall that facilitates the purchase of an annuity.

Pension Lump-Sum

Some pensions allow retirees to take the commuted value of their pension as a one-time lump-sum payment. This cash could be directed into an annuity.

Maturing Investments

GICs, bonds, and other maturing fixed-income investments leading up to retirement provide set amounts of cash that could be used to buy an annuity.

What Are the Main Types of Annuities in Canada?

There are three main types of annuities to suit different financial situations and needs:

Life Annuity

A life annuity guarantees income for as long as you live. Payments continue until death, providing protected income you cannot outlive.

However, life annuity payments generally cease upon death, so no funds go to beneficiaries. This income protection comes at the cost of not leaving an inheritance.

There are several varieties of life annuities:

• Life Annuity Without Guaranteed Period: Stops payments at death
• Life Annuity With Guaranteed Period: Continues payments to the beneficiary for the set term if the annuitant dies
• Life Annuity With Indexing: Payments increase annually by a set amount
• Joint Life Annuity: Continues payments as long as one annuitant is alive

Term Certain Annuity

A term certain annuity pays income for a set period you select, such as 10 or 20 years. This allows your beneficiaries to receive any remaining income if you pass away before the term ends.

The tradeoff is that term certain annuities have lower payment amounts than comparable life annuities.

With a term-certain annuity, the annuity provider will make regular fixed payments to the annuitant until the end of the selected term. These payments are typically made monthly but can also be issued quarterly, semi-annually or annually.

The amount of the periodic payment depends on the purchase amount, term length, age of the annuitant, and current interest rates. Longer term lengths generally result in lower periodic payment amounts.

Variable Annuity

A variable annuity invests the contributed funds into underlying investments with variable returns, such as equities, bonds, and other securities.

The income payments fluctuate based on the performance of the investments. Payments may be higher if investments do well, but lower if they underperform.

Variable annuities share similarities with segregated fund products offered by insurance companies. These segregated funds function like mutual funds but with added insurance features, such as maturity guarantees and death benefits.

Comparison of the Three Primary Annuity Types

Here’s how the key features of the three main annuity types compare:

What Are the Benefits of Annuities?

Annuities can play an important role in a retirement plan by offering valuable benefits, including:

Guaranteed Income For Life

Annuities provide lifelong income you cannot outlive. This protects against the serious risk of depleting your savings while still alive – annuities ensure you have income no matter how long you live.

Immunity from Market Volatility

Fixed annuity payments are preset and guaranteed. This provides retirement income stability since payments will not fluctuate due to economic downturns or markets dropping.

Tax-Deferred Growth

Earnings on deferred annuities grow tax-deferred until payments start. This allows faster accumulation compared to taxable accounts.

Mimics a Pension

For retirees without an employer pension, buying an annuity allows them to create their own personalized pension-like income stream.

Death Benefit Options

While many annuities end payments upon death, certain types allow you to guarantee income for surviving spouses or beneficiaries for a term.

Peace of Mind

The guarantee of predictable lifetime income can provide comfort, financial security, and peace of mind for risk-averse retirees.

What Are the Drawbacks of Annuities?

Despite their benefits, annuities also come with some important limitations to consider:

Illiquidity

Funds used to purchase annuities are locked in and typically cannot be accessed for emergencies or large upcoming expenses. Accessing funds usually involves steep penalties.

No Inheritance

Many annuities cease payments upon the annuitant’s death. Unless specific options are selected, an annuity does not leave beneficiaries any inheritance.

Lower Returns

The guaranteed income provided by annuities generally comes at the cost of lower returns than directly investing in securities. Upside potential is limited.

High Fees

Annuities can come with high management fees, commissions, and early withdrawal penalties. These embedded costs lower net returns.

Limited Flexibility

Once purchased, annuity contracts offer little ability to change terms, adjust payment amounts, or transfer between products. Annuity terms are fixed.

Not Ideal for Early Retirees

Those retiring early may desire more liquidity and growth potential. Annuities lock in income levels decades before actual needs or life expectancy are known.

Who Should Consider Annuities?

Annuities are best suited to certain individuals based on their financial priorities, time horizon, risk tolerance, and overall retirement goals:

Retirees Seeking Income Security

For retirees focused on ensuring lifetime income to cover fixed expenses, annuities provide peace of mind, knowing payments cannot run out while they are alive.

Low-Risk Tolerance Investors

Older individuals who prefer low-risk, guaranteed returns over growth may benefit from annuities versus volatility-prone market investments.

Nearing Retirement

Those within 5-10 years of retirement have a clearer picture of income needs and life expectancy in Canada. Locking into an annuity may be appropriate closer to this stage.

Concerned About Outliving Savings

Retirees worried about depleting assets can use annuities to guarantee a base income level regardless of how long they live.

With Insufficient Retirement Savings

For individuals without adequate retirement savings, annuities can provide lifetime income that may not be supportable from savings alone.

Without Employer Pensions

Self-employed and small business owners can use annuities to create reliable retirement income to replace what pensions provide to employees.

Who Should Avoid Annuities?

On the other hand, annuities may not be the best option for certain retirees based on their needs and priorities:

Those Needing Liquidity

Retirees requiring full access to savings for emergencies, medical costs, or big upcoming purchases are likely better off avoiding illiquid annuity contracts.

Focused on Maximizing Returns

Investors seeking to maximize portfolio growth during retirement should look to stocks, ETFs, and other securities offering higher upside potential than annuities.

Comfortable Managing Investments

DIY investors who prefer selecting and managing their own portfolio throughout retirement will gain little benefit from annuities.

Wanting to Leave an Inheritance

Individuals who prioritize estate planning and leaving an inheritance for beneficiaries should look for options that do not cease payments upon death.

Concerned About Fees

Those seeking to minimize costs and retain more of their investment returns may be better off with low-fee ETFs or robo-advisors over fee-heavy annuity products.

Early Retirees Needing Flexibility

People retiring decades before the average retirement age require maximum flexibility in their plans, which annuities do not provide.

How Much Income Do Annuities Provide?

The amount of retirement income an annuity generates depends on seven factors:

• Age at time of purchase: The older you are when you buy an annuity, the higher the payments. This is because the insurer expects to make payments longer for younger purchasers.
• Gender: Women often receive higher payments than men of the same age because of longer life expectancy.
• Overall health status: Insurers will increase payments if you have certain health conditions that are expected to reduce your lifespan.
• Size of annuity purchase: Obviously, the more money you put into an annuity, the greater the income payments will be.
• Type of annuity product selected: Payments can vary widely depending on if you choose a simple, lifetime annuity or one with inflation protection, death benefits, or other features.
• Length of payout term: You’ll get higher income for shorter payment terms, like 10 years versus lifetime payouts.
• Current interest rates: When rates are higher, insurers can fund larger annuity payments for the same premium amount.

To illustrate, here is an example of potential monthly Canadian annuity payouts:

Monthly Income for a $100,000 Annuity Purchase

This example demonstrates that older retirees will receive higher payment amounts on the same annuity purchase amount compared to younger retirees. Actual quotes will depend on personal factors, product type, and market conditions when purchased.

How Are Annuities Taxed in Canada?

The taxation of annuity income depends primarily on whether the annuity is held within a registered account like an RRSP/RRIF or purchased using non-registered personal funds:

Registered Annuity (RRSP/RRIF)

All income payments are fully taxable as regular income at your marginal tax rate. There is no special tax treatment for registered annuities.

For example, a $60,000 per year annuity payment from a registered RRSP annuity would be fully taxed as $60,000 income.

Non-Registered Annuity

Only the interest/income portion of payments is taxable. The return of your original capital is received tax-free.

For instance, if your $500 monthly payment from a non-registered annuity comprises $200 income and $300 return of capital, only the $200 would be subject to tax.

Two additional taxation factors for non-registered annuities:

• You can elect to receive income as prescribed or non-prescribed annuity payments, which impacts how the taxable amount is calculated annually.
• Annuity earnings grow tax-deferred until payments commence. Once income starts, the taxable portion becomes fully subject to income tax based on your bracket.

How Do You Buy Annuities in Canada?

If an annuity aligns with your retirement goals and income needs, here are seven tips you should consider for purchasing an annuity in Canada:

Understand Your Needs First

Assess your overall retirement budget and determine whether guaranteed annuity income would benefit your plan or if you require liquidity. Then, determine what portion of your assets to annuitize.

Research Providers

Stick to large, established Canadian insurance companies with strong financial ratings when considering annuity providers. Verify they are members of Assuris, which protects annuity holders up to prescribed limits if an insurer fails.

Compare Quotes

Before purchasing, get annuity quotes from at least 3-4 top-rated insurers. Fees and payment amounts can vary significantly between providers for similar products.

Seek Unbiased Advice

Speaking with a fee-only certified financial planner can provide unbiased guidance about appropriate annuity products for your situation.

Understand the Terms

Carefully review the annuity contract terms before committing, including income payment details, fees, withdrawal rules, death benefit or guarantee options, and other restrictions.

Check Tax Implications

Understand how the annuity will be taxed based on whether you use registered or non-registered savings and account for this in your retirement cash flow projections.

Allow Time Before Committing

Avoid rushing into an annuity purchase right before retirement. Give yourself at least a few years to consider all aspects and ensure they align with your overall financial plan.

Key Considerations Before Buying an Annuity

Here are seven additional factors to consider when determining if purchasing an annuity is right for your situation:

Your Time Horizon

If you are retiring at 55, you likely have different income needs and priorities than if you were retiring at 65. Evaluate whether committing to an annuity suits your time horizon. Deferred annuities can allow greater flexibility for younger retirees.

Other Retirement Income Sources

Consider any pensions, CPP/OAS payments, rental income, etc, you may be receiving in retirement alongside annuity income. Assess your total guaranteed and variable income sources.

Liquidity Needs

Unless you have ample savings elsewhere, annuities provide little liquidity. Think about any big upcoming expenses, emergencies, or health costs to understand your liquidity requirements.

Life Expectancy and Health

Your health, genetics, and lifestyle can inform your life expectancy to help optimize when to start annuity payments to maximize the total income received.

Spousal Income Needs

Joint-life annuities can provide income for a surviving spouse after your death. Factor this into the decision based on your spouse’s income needs.

Interest Rates

Higher interest rates at the time of purchase can lead to higher annuity payment amounts. Monitor interest rate trends when considering timing.

Inflation Protection

Many annuities provide fixed payments, so evaluate whether to add inflation or indexed-linked income options to maintain purchasing power over decades.

The bottom line

The road to a rewarding retirement journey involves navigating complex financial decisions.

While annuities offer clear benefits, weigh the tradeoffs smartly based on your unique situation. Approach retirement with eyes wide open, fully prepared. Your golden years deserve financial security.

With thorough planning and products like annuities, you can look to the future with confidence and optimism, embracing the excitement of your next chapter without financial fears holding you back.

FAQs on annuities in Canada