From the world of annuities comes a reason for retirees planning the sale of the family home to get moving before the year is out.
If you want to use part of the proceeds from the sale of a house to generate tax-efficient, zero-stress retirement income, be sure to check out something called a prescribed annuity. Just be quick about it. If you buy next year, you'll pay more tax.
"If someone is interested in buying a prescribed annuity, it's significantly better to do it today," said Clay Gillespie, managing director of Rogers Group Financial in Vancouver. "The difference between this year and next year is quite dramatic."
Buying an annuity means signing a contract with an insurance company to exchange a sum of money for guaranteed income payments lasting as long as you live. Manulife Financial says about 55 per cent of annuities are held in registered accounts, which typically means they were bought with money from a registered retirement savings plan or registered retirement income fund. Prescribed annuities dominate the 45 per cent of the market that is not in a registered account.
An example drafted by Mr. Gillespie using quotes from Canada Life shows that a 70-year-old woman who bought a $100,000 prescribed annuity would receive annual income of $6,375, of which $493 would be taxable under the current rules (the rest is considered to be a return of your original principal). The same payment would apply if the same annuity is purchased in 2017, but the taxable portion would more than double, to $1,056.
The percentage increase in taxable income is even more striking if you buy an annuity at 75. Mr. Gillespie's numbers show that a man at this age who bought a $100,000 annuity would receive $7,776 in annual payments, with the taxable portion rising from $84 this year to $783 in 2017 and afterward. Both men and women who bought annuities late in life, say at 80 years old, might have no taxable income in prescribed annuity payments under current rules. With an annuity bought in 2017, there will likely be a taxable component.
Existing prescribed annuities and those bought before the year is out will continue to be taxed the old way. Also, there is no change to the gross amount of income annuities produce. These payments will continue to reflect a mix of long-term interest rates and mortality credits – money left over by people who die not long after buying annuities and don't use up what they contributed.
This combination of rates and mortality credits accounts for Mr. Gillespie's estimate that you get a rough pre-tax return of about 4 per cent from an annuity if you buy at age 70 and have the typical life expectancy.
The heavier tax hit on prescribed annuities will make them less attractive, but it's not a deal-breaker. Rino Racanelli, an insurance adviser in Toronto who specializes in annuities, continues to see a role for them in the portfolios of people in a high marginal tax bracket who want to reduce their taxable income.
Imagine that someone puts $100,000 in a non-registered, 2-per-cent guaranteed investment certificate and receives $2,000 of fully taxable interest income every year. To illustrate the prescribed annuity alternative, Mr. Racanelli cited data from Sun Life Financial showing that a 70-year-old man who put $100,000 into one of these products in 2017 would receive annual income of $6,885, with $1,002 of it considered taxable income.
Mr. Racanelli said prescribed annuities may be of interest to people who want to limit their taxable income so as not to have their Old Age Security payments clawed back. Another use is for creating a tax-efficient income stream from the proceeds of selling a house. "I've had many of my clients do that – about 35 in the past few years," he said.
One client sold a home for $2-million and invested $500,000 of the proceeds in a prescribed annuity. That's in keeping with Mr. Racanelli's belief that only one-quarter of someone's retirement assets should be locked down in an annuity.
Taxation of registered annuity payments is basic – the money is considered to be fully taxable. Non-registered annuities can be taxed in two ways, one of which is called the accrual method. Here, the taxable portion of your annuity income starts high and declines over time. The prescribed annuity levels off the tax hit by offering a consistent blend of taxable interest income and your own money, which is not taxable.
The changes to the taxable income component of prescribed annuity payouts result from an updating of life expectancy data that go back to 1971. Longer lives result in a recalibration that adds a larger taxable portion to these payments while decreasing the non-taxable part.
If you're interested in a prescribed annuity, don't wait much later than the fall to get serious. Mr. Gillespie said it can be time-consuming for an adviser or insurance agent to gather quotes from various insurance companies about annuity payouts, and processing a purchase can take about three weeks.
His usual practice is to "ladder" annuities by making purchases annually for two or three years. Annuity payments rise as the purchaser's age increases, and there's always a chance that interest rates could drift a bit higher in a year or two. The new taxation rules for prescribed annuities mean he'll de-emphasize this laddering approach for this year to load up on annuities with the current lower tax rate.
Mr. Gillespie is a big believer in all types of annuities because they address the need for stable income that is not affected by what's happening in the stock and bond markets. "I call annuities personal pensions, because that's what they are."
If you're retired and planning to sell the family home, a prescribed annuity offers the opportunity to turn some of the profit into your own personal pension plan. Just remember that, from a tax point of view, these annuities are a lot more attractive to buy now than they will be next year.
Tax hikes ahead for some annuities
Coming changes will increase the tax hit on payments made from prescribed annuities purchased in 2017 or later. A prescribed annuity is bought using non-registered money (i.e., not with money from a registered retirement savings plan or registered retirement income fund). Note that the coming changes will not apply to existing prescribed annuities, or those sold by the end of this year. Also note that the monthly income paid by prescribed annuities will not change. Only the taxable portion of the payment will change. Here are some examples of how the taxable amount on prescribed annuity payments will change from Clay Gillespie, a financial adviser at Rogers Group Financial in Vancouver.
$100,000 Invested – 10 year guarantee*
|Age||Annual Income||Taxable amount before Jan. 1, 2017 ($)||Taxable amount effective Jan, 1, 2017 ($)||% Change|
Source: Clay Gillespie, Rogers Group Financial; Canada Life
*If you die soon after buying your annuity, your estate will receive payments up to the end of the guarantee period