Annuities

From: Financial Consumer Agency of Canada

What annuities are

An annuity is a financial product sold by an annuity provider, such as a life insurance company, that will pay you guaranteed regular income. An annuity is typically used for retirement purposes.

How annuities work

You can purchase an annuity with a lump sum or through multiple payments over time. The income payments you receive from an annuity are a combination of interest, a return of your capital, and a transfer of capital from annuity holders who die earlier than statistically expected to those who live longer than expected.

The annuity provider pays you regular income payments. You can choose to either receive income payments for a fixed period of time or for as long as you live. Depending on the type of annuity you choose, you can receive income payments monthly, every three months, every six months or once a year. You can also choose to start receiving your income payments right away, or to have them start at a later date, which is known as a deferred annuity.

The amount of the regular income payment you get depends on a number of things, such as:

  • if you are male or female
  • your age and your health when you purchase the annuity
  • the amount of money you invest in the annuity
  • the type of annuity you purchase
  • whether your annuity has a guarantee option, which will continue to make payment to a beneficiary or your estate after you die
  • the length of time you want to receive payments from your annuity
  • the rates of interest when you buy your annuity
  • the annuity provider

Types of annuities

There are several kinds of annuities. It is important to understand each type of annuity and what options, benefits and risks each type presents.

Before you buy an annuity, you need to decide:

  • whether or not you want the annuity to continue to be paid to a beneficiary after you die
  • whether you want regular income payment or income payment that will increase or decrease regularly

Life annuity

A life annuity is an annuity that provides you with a guaranteed lifetime income. For example, if you buy a life annuity for $100,000 at age 65 with an income of $500 per month, you get your $100,000 back by age 82. If you live past 82, you will still receive $500 a month as long as you live.

Table 1: Example of a life annuity with a $500 monthly payment starting at age 65
Age of annuitant Number of monthly payments Amount received as income payments Amount gained or lost
70 60 $100,000 $30,000 -$70,000
75 120 $100,000 $60,000 -$40,000
80 180 $100,000 $90,000 -$10,000
82 200 $100,000 $100,000 $0
85 240 $100,000 $120,000 $20,000
90 300 $100,000 $150,000 $50,000

As this table shows, the longer you live, the more income your annuity provides.

In most cases, your life annuity income payments stop when you die and no money goes to your estate or a named beneficiary.

However, some annuity providers may offer the following options so that payments continue to be made after you die:

  • a joint and survivor option, where the income payments continue as long as one of the annuitants is alive
  • a guarantee option, where income payments are continued to a beneficiary or your estate if you die within a specific amount of time
  • a cash-back option, which provides a one-time payment to a beneficiary or your estate if you die before receiving a specific amount of money (usually the amount you paid for your annuity)

These options can be combined, but each additional feature will lower the amount of your income payment.

Term-certain annuity

A term-certain annuity is an annuity that provides guaranteed income payment for a fixed period of time (term). If you die before the end of the term, your beneficiary or estate will continue to receive regular income payments, or receive the balance of the regular payments as a lump-sum.

Table 2: Example of a $100,000 term-certain annuity with various lengths
Length of annuity term (years) Number of monthly payments Regular monthly payment Total amount received
5 60 $1,700 $102,000
10 120 $900 $108,000
15 180 $650 $117,000
20 240 $500 $120,000

This table shows that your regular income payment will usually be lower when you buy an annuity with a longer guaranteed payment term. In addition, the longer your annuity term, the more money you or your beneficiary will make on your original $100,000 investment.

Variable annuity

A variable annuity is an annuity where the annuity provider invests your money in a product with a variable return, such as equities. You receive a fixed income as well as a variable income. The fixed income portion you receive from a variable annuity is usually lower than what you would earn with a non-variable annuity, such as a life or term-certain annuity. The variable portion you receive will fluctuate based on the performance of the investment. This means that you could earn more money if the investments perform well, and less money if they perform poorly. This is in contrast with a non-variable annuity, which provides guaranteed income payments regardless of what happens in the market.

Comparing different types of annuities

Annuities offer different options, pay close attention to the pros and cons of each.

Life annuity

A life annuity is an annuity that provides you with a guaranteed lifetime income.

The pros and cons include:

Pros

  • provides guaranteed income payments for as long as you live
  • no risk of outliving your income
  • you can add a joint and survivor option to transfer payments to your spouse/partner
  • other options can be added to provide money to your beneficiary or estate when you die

Cons

  • you may pass away before receiving all of your money back
  • adding extra options (such as those that provide payments to your spouse when you die) usually means a lower regular payment

Term-certain annuity

A term-certain annuity is an annuity that provides guaranteed income payment for a fixed period of time.

The pros and cons include:

Pros

  • provides a guaranteed income for a set period of time
  • your beneficiary or estate will receive any remaining benefit if you die before the end of the term

Cons

  • you may live longer than the term of your annuity, meaning you could stop receiving income before you die

Variable annuity

A variable annuity is an annuity where the annuity provider invests your money in a product with a variable return, such as equities.

The pros and cons include:

Pros

  • offers a fixed income plus potential extra income linked to market performance
  • you may earn more money than a non-variable life annuity if the investments backing the variable portion of your annuity perform well

Cons

  • your regular income is harder to predict
  • you may earn less money than a non-variable life annuity if the investments backing the variable portion perform poorly

What to consider before buying an annuity

Before buying an annuity, it’s a good idea to take the following into consideration.

When to buy an annuity

If you choose to purchase an annuity, the best time to buy depends on your personal income needs and sources of income.

For example, you may want more money early in your retirement to help pay for travel or new hobbies. Or you may want more guaranteed income later in your retirement years to help pay for the cost of extra health care or accommodations.

If you want more money later in your retirement then you might want to consider waiting to buy an annuity, or purchase an annuity with deferred payments. This means that you pay for the annuity ahead of time but won’t start receiving payments right away. Deferred life annuities provide higher regular payments than immediate life annuities. This is because you will receive fewer payments during your life.

If you are thinking about buying an annuity, consider speaking with a financial professional for help figuring out what the appropriate features are for you, when to buy it and when to start receiving payments.

Your other sources of retirement income

Your retirement income may come from a number of places.

This may include:

  • an employer pension plan
  • registered savings vehicles, such as a Registered Retirement Savings Plan (RRSP) or a Tax-Free Savings Account (TFSA)
  • public pensions and benefits, such as Old Age Security (OAS), the Canada Pension Plan (CPP) or Quebec Pension Plan (QPP)
  • personal savings and investments

An annuity provides you with a regular income during your retirement years. This can make it easier to create a budget and manage your money, especially if you don’t have another regular source of retirement income. For example, you may want to buy an annuity with money from a defined contribution employer pension plan.

An annuity may not be the best option for you if your regular income and savings will already cover your expenses when you retire. You should speak with a financial professional to help figure out whether you will have enough money available to meet your needs when you retire.

The overall price you pay for an annuity can vary between providers

Annuity providers may offer you different income payments for the same type of annuity.

This is because the annuity provider calculates the amount of monthly income they can provide based on several factors such as:

  • the type of annuity (fixed or variable) that you choose
  • the term of the annuity that you choose (life-only, joint life, term certain)
  • your age and gender (so they can estimate your life expectancy)
  • their operating costs
  • the return they expect to receive on their investments

Before purchasing an annuity, ask for a complete listing of fees and commissions. Make sure you understand contract restrictions, including penalties and administrative fees.

Once you think you know what kind of annuity you are interested in purchasing, it is a good idea to compare similar products from several providers.

Whether you want to leave money to a beneficiary or your estate

If you want to leave money to your estate or a beneficiary when you die, you may want to consider buying a term-certain annuity or a life annuity with either a joint and survivor option or a guaranteed payment period.

The annuity option is not the only option. For example, you can keep some of your money in an account or product other than an annuity, like in a personal savings account or TFSA or a Registered Retirement Income Fund (RRIF). Otherwise, you may not be able to do so with a standard life annuity. 

Learn more about making a will and planning your estate.

You may lose money

You will receive more money from a life annuity the longer you live. However, you may not live long enough to get all of the money you paid to buy the annuity in the first place.

Annuities may require a large investment

You may need a large amount of money to buy an annuity. For example, many annuity providers may ask that you invest $50,000 or more to buy an annuity.

Tax implications on annuities

You will have to report the money you get from an annuity as income when you file your taxes. You may have to pay tax on this money. The amount of tax you may pay will vary depending on whether you buy your annuity using money from a registered savings plan, like an RRSP or RRIF, or a non-registered plan, like a personal savings account.

Learn more about taxes and annuities.

How your annuity income is protected

Canadian life insurance companies are required to be members of a consumer protection agency called Assuris. Assuris protects policyholders up to a certain amount in the event that the annuity provider is unable to pay. This means that you will continue to receive at least some of your money if your life insurance company goes out of business.

The income you receive from an annuity covered by Assuris is insured as follows:

  • at 100% for monthly payments up to $2,000
  • at 85% for monthly payments above $2,000

For example, if your regular annuity income is $1,500 per month then you will continue to receive the full amount as this is less than $2,000. If your regular annuity income is $3,000 per month, then you will continue to receive 85% of this amount, or $2,550.

Learn what organizations are members of Assuris.

Annuities cannot be changed or cancelled easily

To buy an annuity you enter into a contract with the annuity provider. Typically, once you buy an annuity, the terms of the contract can’t be changed. This means you can’t switch to a different type of annuity or get your money back.

Your annuity contract may have a cooling-off period. This means that you can cancel the contract without having to pay a penalty within a specific amount of time. Be sure to read your annuity contract carefully to see if it includes a cooling-off period.

You may have the option under the contract to cancel your annuity within a certain time period after you start receiving payments. Typically, there is a fee to do this which can be a percentage of the purchase price of the annuity.

Speak with your annuity provider for more information about the contract and your rights to change or cancel an annuity.

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