PETER DOLEZAL: Annuities: a retirement income option

An annuity is an insurance product which guarantees the holder a prescribed income stream for a specified length of time

An annuity is an insurance product which guarantees the holder a prescribed income stream for a specified length of time. Annuities can have a single-person lifetime payment guarantee, or for couples, a joint-life guarantee. Other options provide payment for a specified minimum period such as 10 years. Although most annuities typically offer an assured flat payment amount, indexed annuities are also available.

The longer the time frame of the selected payment stream — with joint benefit payments, indexing or other costly features — the less the monthly income received.

The older one’s age when purchasing an annuity, the higher the monthly payment will be. For some retirees, annuities are worth considering but only in certain unique circumstances.

There are several key disadvantages to annuities. The greatest of these is that the funds invested in an annuity are generally lost to the annuitant on death. If you happen to have a life annuity and  live to 100, you win. On the other hand, should you die shortly after purchasing the annuity, the insurance company is the big winner. Although insured annuities exist, which preserve the invested capital, the extra cost of insurance drastically erodes the monthly income.

Another major disadvantage is today’s interest rate environment, used by the insurance company in determining the level of payments.

With historically-low interest rates, current annuity payments per $100,000 invested, regardless of the options chosen, are also historically low. With the projected rise in interest rates, this may begin to turn around in favor of the future annuitant.

If an annuity is purchased with RRSP or RRIF funds, all of the income received is taxed as ordinary income, exactly as if drawn from the registered account. However, if the annuity were purchased with Non-Registered funds, major tax advantages would exist, since a significant portion of the payments would be classified as a return-of-capital, which is not taxable.

Generally, annuities do not become a viable option until at least age 65. The longer the projected retirement, the lower the monthly payment will be. Let’s look at four couples, aged 65, 70, 75, and 80. Each is considering the purchase of a joint-life annuity which guarantees specified monthly payments until the death of the second spouse. The capital is not insured; it will be lost on the death of the last partner. Each couple is considering a $100,000 annuity purchase.

As expected (based on a July, 2013 quotation), the youngest couple will receive the lowest guaranteed monthly payment of 5.9% ($492/month). The 70-year old couple’s return rises to 6.6%; the 75-year old’s to 7.4%; and the 80-year old’s to a sizzling 8.9%. Obviously, the insurance company relies on the actuarially-determined probability that the greater the age of a couple purchasing an annuity, the shorter the length of time the insurer will be making payments. Thus the higher monthly payout to the older couples.

For some retirees, the total predictability of monthly income from an annuity provides the peace of mind that makes the downsides of an annuity worthwhile. No general rule of thumb can be applied to everyone, to determine whether or not a particular annuity should be purchased. Each individual’s, or couple’s, net worth, degree of risk-aversion, desire to leave a significant estate for family, tax position, and other personal factors need to be considered.

Is there an optimum time when one might at least consider whether the purchase of an annuity is a good idea in specific circumstances? Generally, an annuity might be best considered if the individual or couple is at least age 70; and aside from an employer pension or RRIF income, also has a significant Non-Registered portfolio. In this case, the attractive payment percentage, combined with the tax advantages, might favor the purchase of an annuity, using a portion of the Non-Registered funds. This would be akin to purchasing a lifetime GIC paying 6 or 7% – which many would jump at, were it available. However, unlike a GIC, purchasing the annuity eventually results in the invested capital being lost to the estate. This latter concern becomes less of an issue for those with no heirs.

Clearly, with the multitude of options and tax considerations, the decision to purchase an annuity is a complex one. If considering an annuity, do your homework before committing. Confer with an independent expert on annuities, and with your accountant. Obtain competitive quotes on the option you are considering, and don’t rely solely on advice from the individual trying to sell you an annuity. That salesperson stands to make a hefty commission for signing you up – hence can not be considered to be totally objective. You need to ensure that the decision you make is best only for you.

 

A retired corporate executive, enjoying post-retirement as an independent financial consultant, Peter Dolezal is the author of three books, including his most recent – The SMART CANADIAN WEALTH-BUILDER.

 

 

Get local stories you won't find anywhere else right to your inbox.
Sign up here

Just Posted

This photo of Cheryl-Lynn Townsin and her daughter, Lexi, is part of Townsin’s documentary, RARE HUMANS - Turning Hope into Action, her capstone project for her graduate degree from Royal Roads University. (Photo courtesy of Cheryl-Lynn Townsin)
Greater Victoria mother’s grief fuels documentary of ‘Turning Hope into Action’

Lexi, 6, died in 2019 from Blau Syndrome and is among the children documented

This dead fir tree is one of many in Mount Douglas Park. Nine dead trees will be removed from the Douglas Creek site starting March 8 to make way for the construction of a new pedestrian bridge. (Photo courtesy Jason Clarke)
Nine dead, hazardous trees to be removed from Saanich park ahead of bridge construction

Felling begins March 8, minor trail interruptions expected in Mount Douglas Park

The City of Victoria filed a petition with the Supreme Court of B.C. March 2 to have it clarify whether, under the Trustee Act, Beacon Hill Park can be used for temporary sheltering. (Black Press Media file photo)
Victoria asks court to clarify if Beacon Hill Park can be used for sheltering

City of Victoria filed petition to Supreme Court of B.C. March 2

Victoria Shamrocks announced on March 2 that Mike Simpson will be taking over as head coach. (Photo courtesy of the Victoria Shamrocks)
Victoria Shamrocks name new head coach ahead of 2021 season

Mike Simpson has been promoted from offensive coach to the team’s bench boss

The application proposing to rezone Western Speedway was passed by Langford’s planning, zoning and affordable housing committee Feb 8. A petition has since been started by residents of Trudie Terrace, hoping to stop the proposed residential portion of the development plan. (CBRE Victoria)
Petition opposing Western Speedway development proposal gains steam

Save Thetis Heights Neighborhood petition aims to stop extension of Trudie Terrace

Older rental apartments are prime candidates for renovations, and could result in lost affordable housing stock. (Zoë Ducklow photo)
B.C.’s renoviction overhaul a good start, but won’t preserve affordable stock, lawyer says

And still no protection for people who can’t pay rent due to COVID-19

(Photo by Marissa Baecker/Shoot the Breeze)
B.C. WHL teams to hit the ice with Kelowna, Kamloops hub cities

Kelowna, Kamloops centres chosen to host B.C. WHL teams for 24-game regular season

The victim of the homicide on Cowichan Lake Road early Monday morning was 17 years old, and was stabbed in the incident. (File photo)
Duncan homicide victim was 17 years old

RCMP report that teenager was stabbed

(Black Press file photo)
Agassiz boy, 11, dies from ‘extensive injuries’: Homicide team

Agassiz RCMP were called out Friday to assist with a child in medical distress

(File photo)
RCMP arrest man after report of gun-toting threat-maker near Parksville schools

43-year-old man taken into custody; students at nearby schools were asked to stay inside

The machines are akin to ATMs and allow drug users at risk of overdose to get hydromorphone pills dispensed to them after their palm has been scanned to identify its unique vein pattern. (CANADIAN PRESS)
Feds dole out $3.5M for ‘vending machines’ to dispense safer opioids in B.C.

The machines are located in four cities across Canada, including Vancouver and Victoria

Kelowna’s lakefront visitor centre is one of 130 around the province. Tourism businesses have been hardest hit by COVID-19 restrictions on travel. (Destination B.C.)
Tourism, small business getting COVID-19 help, B.C. minister says

$300M grant program has delivered $50 million so far

Most Read