Annuities are insurance contracts that convert a lump sum of savings into a steady income stream. When you purchase an annuity you effectively buy a private pension: the insurer returns your capital over time and pays interest on that capital. Part of the income can also come from pooling the remaining capital of other annuity buyers who die earlier than expected.
Payments from annuities can be scheduled monthly like a traditional pension, or paid quarterly, semi-annually or annually, depending on the contract.
An annuity that begins payments immediately after purchase is called an immediate annuity. If the payouts are set to start at a later date, the contract is known as a deferred annuity.
How are annuity payments determined?
Several factors affect the amount you receive from an annuity:
- Your sex: Because women typically live longer than men, annuity providers generally offer lower payment rates for women.
- Your age: The older you are when payments begin, the higher the regular payout, since fewer payments are expected over the annuity’s lifetime.
- Your health: Serious health conditions that reduce life expectancy can increase the payment amount, as the insurer anticipates a shorter payout period.
- The type of annuity: Fixed annuities pay a constant amount. Indexed annuities increase with inflation and often start with lower payments than fixed contracts. Variable annuities include a base payment plus a variable component tied to the performance of an investment pool. There are also tontine-like designs introduced by some firms that boost income for those who outlive their peers by redistributing capital from earlier deaths to longer-lived participants.
- The term of the annuity: Term-certain annuities pay for a specified period (for example, 10 years). Life annuities continue for the annuitant’s lifetime. Buyers can choose a guaranteed minimum period so beneficiaries or an estate receive remaining payments if the annuitant dies early. Couples can purchase joint-and-survivor annuities that pay until the second person dies; products covering two lives or offering guarantees typically pay less than single-life, no-guarantee annuities.
- Interest rates: Payments reflect the long-term interest assumptions insurers use when pricing annuities. Higher prevailing interest rates at purchase generally increase payouts. For example, a 65-year-old woman who bought a $100,000 life annuity with no guarantee might have received about $482 monthly a decade ago and around $539 today. A 65-year-old man would have seen roughly $539 then and approximately $576 today. Although market rates have risen substantially, annuity pricing relies on long-term rate assumptions, so changes in immediate payouts can be more modest than current rate movements might suggest.
How annuities are taxed in Canada
If you fund an annuity with registered money from an RRSP or RRIF, the payments you receive are fully taxable in the same way RRSP or RRIF withdrawals are. While many RRSP holders convert to a RRIF, you can instead use registered savings to buy an annuity.
When an annuity is purchased with non-registered savings, each payment comprises a tax-free portion (a return of principal) and a taxable portion (interest income). At purchase you can elect whether the non-registered annuity will be prescribed or non-prescribed.
A prescribed annuity spreads the taxable income evenly across every payment, which can smooth and sometimes defer taxes. A non-prescribed annuity generally reports more taxable income in the early years and less later, similar to how mortgage interest is front-loaded or how a larger investment balance generates more interest initially.
What are the benefits of an annuity?
Annuities primarily protect against longevity risk—the danger of outliving your savings—making them the inverse of life insurance. They offer predictable, often guaranteed income and bring simplicity similar to a defined benefit pension, which many retirees value. Besides immediate peace of mind, annuities remove market volatility from a portion of retirement income, except for variable or indexed products where payouts can fluctuate.
DIY investors who actively manage portfolios in their 50s and 60s may find annuities more attractive later in retirement, perhaps in their 70s, to reduce portfolio management burdens and secure a dependable income floor.
Annuities can replace part of a fixed-income allocation or cover essential living expenses alongside government benefits such as CPP and OAS or workplace pensions, while investments handle variable spending.
Are annuity payments protected?
Most Canadian insurers belong to Assuris, a not-for-profit organization that protects policyholders if a member company fails. Assuris guarantees annuity payments up to $5,000 per month or 90% of the monthly benefit, whichever is greater. For example, a $5,000 monthly annuity would be fully covered; a $6,000 monthly benefit would be protected up to $5,400 (90% of $6,000). This protection level was increased from $2,000 or 85% before May 29, 2023.
Minimum investment requirements and fees for annuities
Insurance companies typically require a minimum purchase amount for annuities, often between $10,000 and $50,000. A licensed life insurance advisor must sell annuities; their one-time commission usually ranges from about 1% to 3% of the annuity premium. By comparison, investment management fees are commonly charged annually as a percentage of assets under management.
Can you insure an annuity?
A common concern is the risk of dying shortly after buying an annuity. To address this, buyers can add a guaranteed payment period so beneficiaries or an estate receive a set number of payments. Another strategy is the insured annuity: purchasing a life insurance policy alongside the annuity. If the insurance face value equals the annuity purchase amount, the combination can offer similar security to a guaranteed investment certificate while still providing ongoing payments and a death benefit.
What are advanced life deferred annuities?
Advanced life deferred annuities (ALDAs) were introduced in the 2019 federal budget and received royal assent in 2021. An ALDA would permit an RRSP/RRIF holder to use up to 25% of their account, to a maximum of $160,000 (as of 2023), to buy a deferred annuity that must start no later than age 85. Despite the legislative approval, insurers have not widely offered ALDAs to date.
Annuities: The non-pensioner’s pension
Annuities allow retirees without workplace pensions to effectively buy a personal pension plan. They can insure against outliving savings and appeal to conservative investors, older DIY investors, or those whose savings are too modest to justify ongoing advisory fees. While past generations were less inclined to purchase annuities, rising interest rates and a growing population entering retirement mean annuities are likely to receive more attention as a dependable retirement income option.
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Read more from Jason Heath:
- Should you include your pension in your net worth?
- A strategy for non-registered and TFSA accounts in retirement
- Should you withdraw from non-registered or TFSA investments in retirement?
- Planning for retirement with little or no savings to draw on