Whether alongside or instead of a registered retirement income fund (RRIF), an annuity can be a useful component of your retirement plan
By Olev Edur
With interest rates now the highest they’ve been in more than 15 years (since November 2007), retirees seeking a safe haven for their savings—without having to fret about the day-to-day vagaries of stock markets—may once again want to consider fixed-income investments. And for those who want worry-free lifelong security, annuities have become much more attractive.
“There’s been a lot of increased talk about payout annuities lately,” Blake Griffith, a Sun Life advisor in Calgary, acknowledges. “And given current interest rates, it’s a good time to be thinking about them.”
Annuities are financial products available from most insurance companies; basically, in return for committing a lump sum, you receive guaranteed payments for either a specified term or the rest of your life. Once you’ve committed that money, it’s locked in and the payments are fixed for the duration, meaning that you never again need to make any investment decisions about those funds.
Adding some possible immediacy to thoughts of capitalizing on current high interest rates, the general consensus among analysts and advisers is that in another year or two, once inflation has been tamed, rates will start coming down again. As evidence, you need only look at the GIC rates being offered by your financial institution: long-term rates are now lower than short-term, a reversal of the normal state of affairs in the investment industry known as an “inverted yield curve.”
As of March 2023, for example, a one-year non-redeemable compound-interest GIC on TD Canada Trust’s website was quoted at 4.65 per cent, while a comparable four-year GIC was paying 4.0 per cent and the five-year was 4.05 per cent. Similarly, the one-year and five-year rates at Royal Bank were 4.65 and 4.20 per cent, while at Oaken Financial (backed by Home Bank) they were 5.15 and 4.40 per cent.
Since annuities are essentially based on going interest rates, the inverted yield curve also has significance—given the widespread assumption that rates will soon subside, there might be no time like the present for buying, as long as the annuity concept fits in with your overall retirement planning. “Annuities should always be considered as part of a bigger plan for your retirement finances,” Griffith advises.
Choosing the Right Annuity
Annuities can be purchased for a fixed term or for life, and for many retirees, particularly those in good health, the lifetime option can be quite a valuable feature. “With a life annuity, you commit your money and get guaranteed payments for the rest of your life, so you never need to worry about running out of money,” Griffith says. “They’re one of the only investment products that can provide income that’s guaranteed for a lifetime.”
A downside of the lifetime arrangement, however, is that when you pass on, any balance that might otherwise have been payable reverts to the issuer, so if you die earlier than expected, the rate of return isn’t so great. But you can offset this risk to a certain extent by opting for a guarantee period, typically 10 years, at a relatively small cost. If you pass away during this period, a death benefit reflecting the balance of the contract is payable to your beneficiary. “With guarantee periods, the cost to you depends on how long a period you choose,” Griffith says, “but the 10-year guarantee, for example, doesn’t affect the payments very much.”
At Sun Life, as of February 2023, a “prescribed” $100,000 life annuity for a male aged 65 would pay $561.42 monthly, or $6,737.04 a year; adding a 10-year guarantee reduces the monthly payments to $556.10, or $6,673.20 a year. Since women still tend to live longer than men (although this gender gap has been narrowing in recent years), the payments are smaller; for a female aged 65, they’d be $526.95 monthly/$6,323.40 yearly without the guarantee, or $524.83/$6,297.96 with the guarantee.
The term “prescribed” simply means that the tax on payment income is equalized throughout the duration of the contract, rather than being highest at the beginning and lowest at the end. Thus, prescribed annuities represent a form of tax deferral. “They’re quite tax efficient,” Griffith says. “With the accrual method [used in non-prescribed annuities], payments are mostly income at first, and then later they’re mostly your capital, so taxes are highest at the outset. With prescribed annuities, all the payments are considered an equal blend of capital and interest.”
With term annuities (prescribed or not), the income will generally will be higher than with life annuities, simply because, in most cases, the payments presumably will not continue for as long. For that reason, those in less-than-ideal health, or whose family health background would suggest a less-than-optimal life expectancy, may want to forsake the lifetime guarantee and opt for higher payments. Also of note: guarantee periods are moot with fixed-term annuities, because unpaid balances revert to beneficiaries.
Special Rules for Registered Plan Rollovers
Most retirees know that by the end of the year they turn 71, they must roll their RRSP into either a RRIF or an annuity or else the plan will be collapsed and all the proceeds added to their income for the year. If the RRSP is sizable, this could result in a huge tax liability. While many people choose a RRIF because of its investment and withdrawal flexibility, some opt for the simplicity and security of an annuity; some opt for both at once, while others choose a RRIF initially and then opt for an annuity later.
Whatever the strategy, some special rules apply to annuities funded with registered money. First, since registered plan withdrawals are fully taxable, so are the payments from these annuities. You can’t, therefore, buy a prescribed annuity with registered monies.
In addition, if you’re using registered funds, you’re limited to buying either a life annuity or (in some provinces) a term-to-age-90 annuity. If you have a spouse or common-law partner, it must be a joint annuity that provides continuing (albeit perhaps reduced) payments to the spouse or partner. In some jurisdictions, the spouse/partner can, however, waive the right to a joint product before the annuity is purchased.
Despite their seeming simplicity, annuities can be complex financial instruments, so professional advice is important. “When you purchase an annuity, the amount you receive is going to depend on your age as well as your health,” Griffith says. “It also depends on whether it’s a single-life or joint-life annuity. There’s a broad array of choices, with several different features and options for these products, and every feature will affect your payments.”
An option called an “escalator feature” may help compensate for inflation. In the case of Sun Life products, you can choose to apply a fixed annual percentage increase of between one and four per cent to help offset inflation; other vendors’ formulae may differ. “The escalator feature can help offset inflation, but it does affect your payments—they’ll be lower at first,” Griffith says. Indeed, any escalator feature will result in substantially lower initial payments.
Finally, another type of product that may be of interest to those whose incomes may be adequate now but will be lower in future is the “deferred” annuity. With these arrangements, you commit your money but the payments don’t begin until a specified future date; meanwhile, the money continues to compound and grow on a tax-favoured basis. The advanced life deferred annuity (ALDA), for example, allows you to defer the start of payments until the end of the year you turn 85.
The Importance of Shopping Around
Because each annuity issuer will have its own rate structure based on its unique claims and payment experience, product yields can vary from one vendor to another for each type of product. For that reason, it’s always a good idea to shop around and compare various vendors’ offerings before making a choice.
To that end, the Cannex Income Annuity Exchange may be a good starting point if you’re considering an annuity purchase. Cannex provides annuity quotes and illustrations on behalf of most annuity issuers in Canada, and pricing examples from different companies can be found on the company’s website, at cannex.com.
Also, if you’re shopping around, always look for a company’s membership in Assuris—a not-for-profit industry-funded organization that protects Canadian policyholders if their life-insurance company should fail. This is similar to the coverage provided by Canada Deposit Insurance Corporation (CDIC) when it comes to financial institutions such as banks or trust companies. Visit assuris.ca for more details on annuity coverage and its limits.
Finally, when you’re doing your annual tax return, don’t forget that, just like income from a RRIF, payments from an annuity qualify for the $2,000 annual pension income credit on your tax return, once you’re 65 or older.