Saving for your retirement can seem a little confusing. How much will you need to live during retirement? How much do you need to save regularly until then? What’s the best savings plan to follow? It doesn’t help that the government occasionally changes its policies on CPP, GIS, OAS and other forms of retirement income.
An annuity lets you turn your savings into regular payments during retirement. You can purchase an annuity from an insurance company, and get income for life. Let’s walk through what you need to know about getting an annuity in Canada.
An annuity is an insurance product that offers an annual income for the rest of your life in exchange for a single, one-time lump sum. The sum is typically drawn from your existing savings. Payments can be annually, semi-annually, quarterly or monthly.
Under this arrangement, you and your insurer are betting against each other. The insurance company is hoping that it doesn’t end up paying out more than you paid. You’re hoping to live long enough to get more than you initially paid.
Annuities require a large, upfront amount. This may be as high as $50,000 minimum. If you don’t have a pile of savings on hand, an annuity may not be the right financial solution for you. Check out our guides on retirement savings accounts and how to avoid debt in retirement to learn more about strengthening your financial position for your golden years.
An annuity rate is the amount of your savings that the provider will pay out each year. Say you have $250,000 saved and you get a rate of 5%, you’ll get an annual income of $12,500 every year until you die.
If the annuity provider believes that you’re statistically likely to dye soon, it will offer a higher rate (meaning, you’ll get more money). If it thinks you’re more likely to live a long time, you’ll be offered a lower rate.
There are loads of different types of annuity on the Canadian market.
This is the most straightforward arrangement. With a life annuity, you get a fixed amount regularly as long as you live. Say you buy an annuity worth $150,000 at 65 years old with monthly payments of $750. You will have received $150,000 total by the time you’re 82. If you live past that, you still get $750 a month even though the insurance company has already paid out all of the savings you initially paid it.
Similar to a life annuity, a term-certainty annuity gives you a fixed income payments. Unlike a life annuity, you only get these payments for a fixed period of time (term). If you pass away before the term is up, income payments will continue to be paid to your beneficiary or estate. Alternatively, your beneficiary or estate could receive a lump sum.
If you feel comfortable assuming more risk, you could opt for a variable annuity, which divides your income payment into 2 parts: fixed and variable. With a variable annuity, your insurer invests a portion of your savings. The income earned from these investments can vary, which is why a portion of your income payment is variable. On the other hand, the fixed portion of your payment is a set amount, which is typically lower than you would receive with either a life or term-certain annuity.
As with most things, this depends on you personal preferences, health and individual circumstances. As with anything concerning retirement finances, it’s important to get advice before buying in.
Consider the following questions:
You have to pay income tax on your annuity payments like you do with other forms of income. This means you’ll declare your annuity payments on your tax return for the year in which you received those payments. The total income tax you’ll pay depends on your total income from all sources, including your annuity, CPP, OAS and employer pension payments.
However, you can potentially lessen your tax obligation if you hold your annuity in a non-registered account like an RSP (different to an RRSP). Fortunately, for annuities in non-registered accounts, you’re only taxed on the interest portion of your payments. You can also save on taxes by holding your annuity in a Tax-Free Savings Account (TFSA), although you can only do this for variable annuities, not life annuities.
The exact options available to you may vary between insurers, but generally you’ll choose between the following options when buying an annuity. Choosing more than one option may lower your payments.
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