Despite seeing a barely perceptible decline in growth over the last 5 years, the Canadian life insurance and annuities market size is still a resounding $87.1 billion industry in 2022. In addition, as annuities are primarily products used by the country’s retired population, this figure is expected to increase as life expectancy and the number of retirees increases.
While a study in 2018 found that 62% of Canadians between 55 and 75 are concerned that they will outlive their savings, only 1 in 10 Canadians were planning on using an annuity to ensure a guaranteed income throughout retirement. Could this be because not enough people know what annuities are and how they work?
This article breaks down common questions about annuities. Learn how they can be used to provide you with an income during your retirement years.
What is an annuity?
An annuity is a financial insurance product that provides the annuity holder (purchaser) with a guaranteed income through retirement. Usually purchased from life insurance providers, the annuity can be bought with a single lump-sum payment or several smaller installments over time.
Annuities are a type of insurance product that transfers the risk of decreases in investment markets and inflation to the insurance company. The annuity owner is protected from market fluctuations which could negatively affect their income and increase the risk of outliving their savings.
Annuities are most commonly bought by retirees to provide them with peace of mind and a steady income throughout retirement. As there are several different annuities that provide different forms of payment, it is important to know how they work before one is bought.
A good financial advisor can help you to decide if an annuity is right for you and your retirement.
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How do annuities work?
An annuity offers the annuity buyer a guaranteed fixed income in exchange for a significant upfront amount of money. They are most often sold by life insurance providers. The provider will consider multiple variables when determining the rate of the guaranteed income. These variables include age and gender as they relate to your life expectancy, but also financial factors such as interest rates, the sum invested (capital) and contract length.
When an annuity is bought, the life insurance provider will review all variables and calculate the amount of monthly income you will receive based on how much you have contributed and how long you wish to receive payments.
Considering the variables, a $100,000.00 annuity in Canada would pay $453.08 per month before tax in guaranteed income for the rest of your life if purchased by a 65-year-old male with payments starting immediately.
Other variations on how much a $100,000.00 annuity would pay per month can be seen in the table below. As can be seen, the amount of annuity income depends on the age of the policyholder at the time the annuity is purchased.
|Age of Annuity Purchase||Monthly Payments (Female)||Monthly Payments (Male)||Annual Annuity Income (Female)||Annual Annuity Income (Male)|
You may hear the term annuitization. It is commonly used and refers to the purchase of the annuity to receive the guaranteed income.
What is annuity income?
The annuity income is the money that you receive from the annuity product which you have purchased. Depending on the type of annuity you hold, you can receive the annuity income monthly, quarterly, semi-annually or annually.
The annuity income that you will receive depends on several factors including:
- Your initial capital that you used to purchase the annuity
- The interest you earn on your initial capital
- How long you wish to receive the income
Who are the best annuity providers in Canada?
A few of the most popular annuity providers in Canada include Sun Life, Manulife and BMO Insurance as they offer several different types of annuity products. However, the best annuity and annuity provider depends on your specific financial situation, age, expected retirement income from pension plans and retirement lifestyle.
Before opting for one solution, consider your options by reviewing some of the best annuity providers in Canada in the list below. These providers also have their own annuity calculators which you can use to find the best annuity income rates for you.
- Bank of Montreal (BMO) Insurance
- Canada Life Assurance Company
- CIBC Wood Gundy
- Desjardins Financial Security
- Royal Bank of Canada (RBC) Insurance Services
- Sun Life
Again, what is the best annuity depends on your personal financial situation. A financial expert can break down the options with you and help you to secure your financial future.
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What is the best type of annuity?
Similar to any other financial product, there are several different types of annuities. Each annuity type comes with its own benefits and can be more or less suitable to your specific situation.
Popular types of annuities include:
- Guaranteed life annuities
- Term certain annuities
- Variable annuities
- Deferred annuities
We explore all below, but before deciding on a specific type of annuity you need to consider:
- How much income you will need
- How long you will need to receive an income
- How much risk you are willing to take
- If you want any payments to be made to a beneficiary when you pass away
- If you want the remaining capital to be paid to a beneficiary when you pass away
The more perks you want to add to your annuity policy, such as having your remaining capital paid to a beneficiary, the lower your annuity income is likely to be.
What is a guaranteed life annuity?
The guaranteed life annuity, or simply life annuity, provides the purchaser with a guaranteed income for the rest of their life. It can be purchased from any Canadian life insurance company using money that you have accumulated from either registered or non-registered accounts. This means that you can use your registered retirement savings plan (RRSP) funds to purchase your annuity and your RRSP issuer will not withhold tax. Similarly, you can fund an annuity from your registered retirement income fund (RRIF).
Since the life annuity guarantees an income for the rest of your life, the life insurance company takes the risk that you will outlive the average life expectancy. In this case, they could have to pay you more in annuity income than they received from your initial capital (premium). Due to this, most guaranteed life annuities will not pay any money to your estate or beneficiaries upon your passing.
What is a term certain annuity?
The term certain annuity, also known as a fixed-term annuity, provides the annuity holder with a fixed income for a pre-determined period (term) of time. Similar to the life annuity, the term certain annuity can be purchased from life insurance providers with money from registered (RRSP, RRIF) or non-registered accounts.
All the capital (money) used to buy the term certain annuity will be paid out to the policyholder during the term. Should you pass away before the end of the contractual term, the remaining money will be paid to a named beneficiary or your estate. If you reach the end of the term, the contract ends and you will receive no further income from the fixed-term annuity.
What is a variable annuity?
In contrast to guaranteed life and term certain annuities, the variable annuity does not offer a wholly guaranteed annuity income. Instead, the variable annuity offers a mixture of a fixed income and a variable income.
With a variable annuity, a life insurance provider invests your capital into stocks, bonds and other assets depending on your choices and risk profile. If the investments do well then your variable income will increase and you will receive more money, but if they perform poorly you will receive less.
Since the variable annuity is investment-based, you can lose money if the investment performance is negative.
What is a deferred annuity?
A deferred annuity differs from an immediate annuity in terms of when you start receiving the annuity income. With a deferred annuity, you will make payments into your annuity through the life insurance provider but will defer the returned income until a later, fixed date. This option allows your initial capital to grow tax-deferred until the annuity starts paying you.
The immediate annuity provides the annuity holder with annuity income immediately. There is no accumulation phase of funds into your annuity and so the immediate annuity simply distributes your income upon purchase. Both deferred and immediate annuities can be fixed (guaranteed) or variable as described by the types of annuities above.
What are the pros and cons of annuities?
Annuities are a great retirement tool for some people, but not for others. Whether they are suitable for you or not depends on your particular financial situation, age and overall lifestyle. For example, if you already have a sufficient income through retirement by the means of a pension plan, CPP, OAS or rental income then they may not be for you.
Annuities pros and cons include:
- You can receive guaranteed income throughout retirement
- Annuities are not one-size-fits-all and you can find a type of annuity that suits you best
- A surviving spouse or named beneficiary can continue to receive your annuity income after passing
- You can protect yourself from market risk and the risk of outliving your savings
- You may not receive your full capital in income if you don’t live long enough
- No liquidity as your capital is looked in with the life insurance provider
- Requires a large initial sum of money in either lump-sum or multiple payments
- You can lose money in a variable annuity
- Life insurance companies charge large fees and commissions
RRIF vs annuities
Many Canadians accumulate wealth tax-free through registered retirement savings plans (RRSPs). However, upon reaching 71 the RRSP has to be closed and withdrawn money will be subject to tax.
To encourage individuals to fund their retirements, the Canadian government allows RRSP funds to be converted into a registered retirement income fund (RRIF), tax-free. Another tax-free option is for the RRSP fund to be rolled into an annuity. The result is that a lot of people are considering which is better between an RRIF or an annuity.
You should consider an RRIF over an annuity if:
- You want control over how your money is invested
- Want to be able to withdraw as much money as you want from your accumulated funds
- Enjoy continued tax-free growth
- Want to use some of your RRIF assets to buy an annuity
- You want more estate planning options
- You have a short life expectancy
- You already have other pension plans that will provide you with a guaranteed income
You would want to consider an annuity over an RRIF if:
- You have limited sources of guaranteed income (pensions, OAS, CPP)
- You want peace of mind and a guaranteed income for life or a certain period
- Have money outside of an RRSP that you wish to convert into guaranteed income
- You don’t know enough to be able to effectively control your investments
- You want simplicity
Still can't decide between an RRIF and an annuity? A financial advisor can help explain which is a better fit for you.
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