Your annuity income is calculated at the time you buy the annuity. It’s based on a number of factors. The most important ones are interest rates and your life expectancy. If you're buying a life annuity, the insurance company uses insurance tables to project how long you are likely to live.
1. Current interest rates
If interest rates are high when you buy your annuity, your annuity payments will be higher than if interest rates were low. That's because the financial institution predicts it can earn more by investing your money.
2. The amount you deposit
The more money you put into your annuity, the more you get back as income.
3. Your age
The older you are when you buy the annuity, the higher your annuity payments will be. That’s because you're not expected to live as long.
4. Your gender
Women get less money than men of the same age because they are expected to live longer.
5. The length of time the payments are guaranteed
You choose the number of years you receive payments with a term-certain annuity. The shorter the term, the higher the payments. If you have a life annuity, you can arrange for your annuity payments to continue to your spouse, your dependent children, or your estate after you die. The longer you want payments to continue after your death, the less you get each month while you’re alive.
6. The options you add
You get the highest income with a basic annuity that covers only you. Any options you add (like a joint-and-last survivor option) will lower the amount of your payments. That’s because these extras increase the costs to the insurance company.
If interest rates are low when it's time to convert your RRSP into an income option, you may want to delay buying an annuity. Instead, you can open a RRIF. When interest rates rise, you can then use your RRIF to buy an annuity.
If you have a serious medical condition
Some life annuity providers will also factor poor health into an annuity quote if you have a serious medical condition. This means your annuity payments will be higher because your life expectancy is shorter.
Paying tax on your annuity income
If you buy an annuity with money from a registered plan
If you buy an annuity with non-registered money
You'll only pay tax on a portion of the payments you receive. That’s because you have already paid tax on this money. Here’s how it works:
To make your regular payments, the annuity provider pays out some of the income it earns investing your money, together with some of your original principal.
In the early years of your annuity, the Canada Revenue Agency (CRA) considers most of the income you get as interest for tax purposes. That means it will be fully taxed.
In the later years, the income you receive is mostly from your principal. Since you have already paid tax on that money, your taxes go down over time.
Deferring tax on annuity income: One way to defer paying tax on your annuity income is to buy a prescribed annuity with after-tax money. The annuity provider will include the same amount of principal and interest for each payment. This evens out the portion of your payment that is subject to tax, and means you pay less tax in the early years.
Content in this section is provided in partnership with Investor Education Fund, a non-profit organization founded and supported by the Ontario Securities Commission that provides unbiased and independent financial tools to help Canadians make better money decisions. To find out more, go to: GetSmarterAboutMoney.ca
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