Before you buy an annuity, it’s important to think carefully about how well it fits your personal situation and overall financial plans. These questions can help you get started.
Is a regular, secure income important to you?
A life annuity takes away a lot of unknowns from your financial plans. However, before you buy, look at how much regular income you will get from other sources. This includes government pension plans and a defined benefit pension, if you have one. Set up your annuity to provide any extra income you need.
Are you concerned about providing income to loved ones after your death?
An annuity can offer a death benefit, but you’ll pay extra for this feature. Another option is to buy life insurance to replace the money you’re going to invest in an annuity. The insurance money will not be subject to fees when your estate is settled. It goes directly to your beneficiary after your death.
Are you worried about inflation in the years ahead?
You can buy an indexed annuity to ensure that your income will go up when prices rise. Again, you’ll pay extra for this feature, but it may be worth it – especially if you have no other sources of income.
How will taxes affect your annuity income?
If you buy an annuity with tax-sheltered savings – such as money from a pension plan, Registered Retirement Savings Plan (RRSP), or Registered Retirement Income Fund (RRIF) – you will pay income tax on all the money you receive. If you buy an annuity using unsheltered money, it’s a little different. That’s because you have already paid tax on those dollars. Here’s how it works:
- To make your monthly payments, the annuity company pays out some of the income it earns investing your after-tax dollars, together with some of your original principal.
- In the early years, the Canada Revenue Agency considers most of the income you get as interest for tax purposes. You will pay tax at the same rate as you would on any other income, including income from work.
- In the later years, the income you get is mostly from your principal. Since you have already paid tax on that money, your taxes go down over time.
Make sure you think about the taxes you’ll pay on your annuity and compare it to any other sources of income you’ll have. If you plan ahead how everything is going to work together, you may be able to minimize your tax.
Remember: An annuity can have an impact that reaches far into your financial future
You have to think ahead because, in most cases, you can’t reverse your decision. A financial expert can help you find the best strategy for your own situation.
Content in this section is provided in partnership with the Investor Education Fund, a non-profit organization promoting financial literacy to Canadians. To find out more go to GetSmarterAboutMoney.ca.