People are finally showing some curiosity about the annuity option for retirement planning. I've been writing about life annuities for years, but it was only with a column published here two weeks ago that readers began asking a lot of questions about how these generators of income-for-life work (read it online here). Here, some of the most interesting questions have been gathered up with answers supplied by insurers and advisers.
How are annuities taxed?
A registered annuity, funded with money from a registered retirement savings plan or registered retirement income fund, generates payments that are fully taxable as regular income. Data supplied by Manulife Financial show 55 per cent of annuity assets are registered;45 per cent are in non-registered accounts.
There are a few types of non-registered annuities, but let's concern ourselves only with the prescribed annuity. These annuities are taxed quite advantageously, and they're widely accessible to individuals. Payments in a prescribed annuity are considered to be a blend of your own capital being paid back to you and interest. Tax is paid on the interest portion, says John Natale, assistant vice-president of tax, retirement and estate planning services at Manulife.
In the accompanying table (below), you'll see how taxes might amount to zero on payments from prescribed annuities bought at age 65 or 70. You'll also notice that changes are coming that will increase the taxes on prescribed annuities starting in 2017. "The simple message is that Dec. 31, 2016, is definitely a deadline to be aware of," Mr. Natale says.
The formula used to calculate the taxable amount in an annuity payment includes a projected lifespan for the annuity buyer. Longer lifespan expectations will come into play in 2017, and that will result in more tax payable in our example. Even so, Mr. Natale points out that not even 10 per cent of the payments from the annuity example in our chart would be taxable under 2017 rules for a 65-year-old male. "It's worse than it was, but it's still very tax-effective," he says.
How are insurance agents and advisers compensated for selling annuities versus other products?
Clay Gillespie, financial adviser and managing director at Vancouver's Rogers Financial Group, says he would get a commission of roughly 2.5 per cent on money clients use to buy an annuity. By comparison, he says advisers and their firms could make more than that over just a few years on a fee-based account in which the client pays 1 per cent of assets. "Annuities don't pay quite as well as other investment strategies."
What age is best to buy an annuity?
Rino Racanelli, managing partner at MRH Financial Services and a contributor to the magazine Canadian MoneySaver, suggests 70 and up. Why so late? Because the later you buy, the shorter the period of time the insurer selling an annuity expects to have to pay you. As a result, payments are higher than they would be if you bought at a younger age. "The older you are, the better it is," Mr. Racanelli says. "And if you're a man, it's even better because your life expectancy is not as high as a woman's."
How can I compare annuity rates?
Part of the reason why annuities have limited popularity is that it's extremely difficult to compare payouts from various insurers. You may be able to find an insurance company that offers an online annuity calculator for its own products – RBC Insurance has one, for example. But comparing that payout with those from other companies based on your particular needs is hard to do on the Internet without having to supply your name and personal information. Mr. Racanelli suggests contacting life insurers directly to see what rates they offer.
Where can I buy them?
Advisers licensed to sell insurance products offer them, and so do agents working for life insurance companies. The insurance arms of major banks may also sell annuities.
Is there a do-it-yourself annuity that you can buy yourself?
No. "Annuities are sold through a financial adviser," says Steve Parker, Manulife's assistant vice-president of guaranteed investment products. "There's nothing there that you can do yourself and bypass the adviser."
Why do annuity rates vary so much between insurers?
Mr. Racanelli says insurers use these factors to set returns on annuities: Age, gender, how much the client is putting in, interest rates and the company's own financial position. It's the latter variable that may explain why some companies are paying notably more than others at any given time.
"Sometimes they decide they want to be aggressive on annuities, and sometimes they don't," Mr. Racanelli says.
"There are lots of companies out there that would rather be pushing segregated funds because they think they can make more money there."
A company's changing needs can alter its pricing of annuities over a short period of time. Mr. Racanelli says that not too long ago he got a quote for a 74-year-old client on a $250,000 non-registered prescribed annuity with annual payments of $21,000. When he checked again a month later, the payment from the same company had fallen by $1,000 per year.
What life expectancy and interest rate calculations are used in pricing annuities?
Manulife's Mr. Parker says insurers will take life expectancy numbers from Statistics Canada and the Canadian Institute of Actuaries and add data drawn from the experience of their own clients. Statscan's life expectancy projections right now are that at age 65, a man will live to 83.5, and a woman will live to 86.6. At 70, a man could expect to live to 85.3 and a woman to 87.6. Interest rates are based on the yields for assets an insurance company can buy to back its commitment to pay annuity clients – mainly corporate and government bonds and mortgages.
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Annuities and taxes
Here’s a look at how taxes apply to a non-registered prescribed annuity bought from Manulife Financial with $100,000. It’s assumed here that payments from the annuity are guaranteed to the buyer or his/her beneficiary for 10 years after purchase. Also, the first instalment of monthly income starts exactly one month after the purchase of the annuity. Taxes are higher starting in 2017 because longer lifespan expectations will be adopted then. Lifespans have a big impact on the formula used to determine the taxable portion of non-registered prescribed annuity payments. Note: In a registered annuity, typically bought with money from a registered retirement savings plan or registered retirement income fund, payments are treated as regular income.
|Age 60||Age 65||Age 70|
|Annual Income (i.e. 12 x monthly)||$4,943.52||$4,748.88||$5,421.96||$5,185.56||$6,142.68||$5,833.92|
|Annual Income reported as Taxable Income under current tax rules||$313.87||$683.80||$0.00||$354.59||$0.00||$0.00|
|Annual Income reported as Taxable Income for purchases after Dec. 31, 2016||$799.30||$1,024.50||$500.70||$772.50||$256.86||$517.60|