How Do Annuities Work in Canada?

Retirement can span decades, yet research shows a large percentage 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. Read on to learn how an annuity works, weigh the pros and cons, and assess if integrating them into your retirement plan can help maximize certainty while avoiding the angst of unknown longevity.

What is An Annuity?

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

This product allows you to convert your retirement savings into a predictable stream of income, providing financial security regardless of market conditions..

An annuity has two main phases:

Accumulation Phase

This is the period when you fund the annuity. You can make either:

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

Annuitization Phase

This phase begins when the insurance company starts making regular income payments to you (monthly, quarterly, semi-annually, or annually) based on the details in your contract. Lifetime annuity payments continue until death, even if this extends past life expectancy.

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 An Annuity

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

Sources	Features
Registered Retirement Savings	Funds from RRSPs or RRIFs. These tax-deferred savings vehicles are designed to provide funds for retirement income.
Non-Registered Investments	Proceeds from non-registered investment accounts, including stocks, bonds, mutual funds, and bank deposits.
Sale of Business or Property	Capital gained from selling a business, commercial real estate, or other valuable property before or upon retirement.
Inheritance	Inheritance of cash, investments, or property could provide a lump-sum windfall that facilitates the purchase of an annuity.
Pension Lump-Sum	A one-time lump-sum payment that can be converted into a stable income stream. 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 primary categories of annuities: Life annuity, Term certain annuity, and Variable annuity. Each is designed for different financial situations and needs.

Life Annuity

A life annuity guarantees income for as long as you live, providing protected income you cannot outlive. However, as payments stop at death, no funds are distributed to beneficiaries. This income protection comes at the cost of not leaving an inheritance.

There are some types of life annuities that continue to provide payment when you die:

• 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: Payments continue as long as one of the two annuitants (typically spouses) is alive. The payment amount may be reduced after the first death.

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 a term certain annuity has 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

Feature	Life Annuity	Term Certain Annuity	Variable Annuity
Payment Duration	Lifetime	Fixed term period	Fixed-term period
Payments Guaranteed for Life?	Yes	No	No
Payments Continue to Beneficiaries?	No	Fixed-term period	No
Payment Amounts	Fixed	Fixed	Fluctuates
Growth Potential	None	None	Yes, based on investments
Income Stability	Very stable	Very stable	Can fluctuate
Access to Remaining Value	None	Beneficiaries if the annuitant dies pre-term	None

How Much Income Does An Annuity Provide?

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

• Size of annuity purchase: Obviously, the more money you put into an annuity, the greater the income payments will be.
• 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.
• Type of annuity product selected: Payments can vary widely depending on whether 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:

Age at Purchase	Monthly Income
60	$600
65	$660
70	$713

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

When you use after-tax money from a savings account or a non-registered investment, your annuity payment is split into two parts. The return of your original capital is received tax-free; only the interest/income portion of payments is subject to tax based on your bracket.

You can elect to receive income as prescribed or non-prescribed annuity payments, which impacts how the taxable amount is calculated annually.

• Non-Prescribed Annuity: The interest portion of your payments is higher in the early years and lower in the later years. This means you have a higher tax bill initially, which declines over time.
• Prescribed Annuity: This is often the preferred method. A prescribed annuity averages the taxable interest portion evenly over the life of the contract. This results in a level, predictable, and often lower annual tax bill compared to a non-prescribed annuity in the early years.

Example: Prescribed Non-Registered Annuity

If your $1,000 monthly payment consists of $700 return of capital and $300 of prescribed interest, you only add $300/month ($3,600/year) to your taxable income, not the full $1,000.

How Do You Buy An Annuity 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:

Step 1: Financial Assessment

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.

Step 2: 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.

Step 3: Seek unbiased advice

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

Step 4: Compare quotes

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

Step 5: Carefully review the contract

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

Step 6: Funding the annuity

You will complete the application and arrange for the transfer of funds, either from your RRSP/RRIF provider or from your bank account for non-registered funds.

Note: You should 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. An deferred annuity 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, an annuity provides 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.

How Annuities Are Protected in Canada

In Canada, annuities are protected by a robust consumer protection framework designed to safeguard policyholders in the unlikely event that their life insurance company fails. This protection is provided by a not-for-profit organization called Assuris.

Assuris provides specific protection for income payments from annuities, such as those from a life annuity or a term certain annuity. The guarantee is that you will retain the greater of $5,000 per month or 90% of your promised monthly income.

These protection limits apply separately to registered (RRSP, RRIF, LIRA) and non-registered funds, even if held with the same insurance company. However, all registered funds with one company are grouped together for one protection limit.

For annuity products that are still in the accumulation phase, where you are paying into them but not yet receiving income, the protection is different. For these products, Assuris protects the guaranteed value (like maturity or death benefits) up to the greater of $100,000 or 90% of the guaranteed amount.

While the Assuris safety net is strong, it is still a best practice to purchase annuities from large, financially stable insurance companies with high credit ratings to minimize risk.

The Pros and Cons of Annuities: A Summary

In conclusion, an annuity plays an important role in a retirement plan by offering valuable benefits, but it also comes with some limitations to consider.

Pros	Cons
A lifelong income that protects against the serious risk of depleting your savings, immune to economic downturns or market drops.	Funds used to purchase an annuity are locked in and typically cannot be accessed for emergencies.
Earnings on a deferred annuity grow tax-deferred until payments start.	No value left for your beneficiary.
For retirees without an employer pension, purchasing an annuity enables them to create a personalized pension-like income stream.	You trade the potential for high market returns for the certainty of a fixed income.
The predictable lifetime income provides peace of mind. No need to manage investments.	An annuity can come with high management fees, commissions, and early withdrawal penalties.

Carefully weigh the trade-offs based on your personal need for security and flexibility, and your overall financial plan. With thorough planning you can look to the future with confidence and optimism, embracing the excitement of your next chapter without financial fears holding you back.

FAQs about Annuity in Canada

Article Sources

• Annuities – canada.ca