Answers to Common Annuity Issues

Questions about life annuities from retirees and pre-retirees

Many retirees or pre-retirees often have questions regarding annuities, such as what taxes will you need to pay, if you should buy a single life or a joint-life annuity, possible ways to balance your income needs, how to maximise your income if you have health problems etc.

In this article we try to provide information on a few of the questions that may trouble you. P.S. note that these are only sample solutions to general scenarios and you should talk to a licensed annuity broker to get your own income figures.

Taxation of Life Annuities

There are 8 different approaches used in taxation of life annuities:

Non-prescribed annuities / Accrual Taxation

Payments from non-prescribed annuity are a blend of interest and capital and the interest is taxed as it accrues – a process called accrual taxation. The taxation is higher in the early years and decreases over the life of the contract as the capital decreases. This results in different monthly payments each year.

Accrual taxation

Accrual taxation can only apply if certain conditions are in place.

• The annuity must be non-registered.
• The annuity may be a Single Life, Joint and Survivor Life or Term Certain annuity.
• Guarantee of payments may not exceed the annuitant’s 91st birthday.
• Payments must commence no later than the 31st of December of the year after purchase.
• For term certain annuities, the owner and payee must be the same person.
• For life annuities, the annuitant, owner and payee must be the same person.
• The purchaser/annuitant must be an individual (not a corporation) or a specified trust.
• Payments cannot be indexed.

If an annuity qualifies as a prescribed annuity, most companies will automatically issue it as a prescribed annuity unless a client requests otherwise.

Prescribed annuities / Prescribed Taxation

Payments from a prescribed annuity are treated as a level blend of interest and capital. In this case your payments remain level for the lifetime of the contract.

Tax treatment of registered plans and pension funds

All annuity income from these plans is 100 percent taxable for registered or pension funds. To initiate the process for a consultation as to what type of annuity may best suit your needs, visit www.lifeannuities.com.

Tax treatment of non-registered annuities

Only the interest component of the payment is taxable in non-registered annuities. Everything else is tax-free, since you paid taxes on the money you contributed to begin with.

Optional withholding tax

With registered annuities and with some non-registered annuities, the annuity owner can opt to have tax withheld. However, non-registered policies with accrual taxation cannot be withheld.

Income Splitting

Income from a life annuity may qualify for income splitting to allow the policyholder to transfer to their spouse, up to 50 percent of the taxable income earned from the life annuity. The income splitting is done by the policyholder on the annual tax return. A tax slip will be issued to the policyholder for the full taxable amount.

Pension income tax credit

Income from a pay-out annuity may qualify for the Federal Pension Income Tax Credit. This credit can be claimed in the non-refundable tax credit portion of a client’s tax return if the taxpayer has eligible pension income. The maximum credit for the year 2017 is $2,000.

Potential creditor protection

If the annuity is purchased with locked-in money, the contract and the income may be protected from creditors based on applicable pension legislation. If the annuity is purchased with non-locked-in money during the guarantee period, the contract and income may be protected.

Common Annuity Scenarios and Possible Solutions

Scenario #1: Single Life vs. Joint Life Annuities

The Problem

Should this couple buy a joint life annuity or a single life annuity on one partner?

The Facts

Here we have a husband aged 66 with a seriously ill wife aged 62, with a diminished life expectancy.

The Questions

1. How can we consider who may die first?
2. How can the seriously ill wife be cared for in the event her husband dies first?
3. Is the difference in income generated by a single and a joint annuity, an important factor in the decision?
4. Should she apply with her husband for an impaired annuity?

The Answers

Even in the event her husband predeceases her, her diminished life expectancy will not change. But she would continue to receive payments for the balance of her life with a joint life annuity.

A joint life annuity will pay $300 less than a single life annuity on the husband alone in a 20 year guaranteed policy.

The Choices

She will not live another 20 years. The extra $300 will help either survivor.

The Decisions

It was decided not to apply for an impaired joint annuity but a single life annuity on the husband, guaranteed for 20 years and life.

Scenario #2: The Cost of Waiting

The Problem

A widow who desperately needs guaranteed income.

The Facts

The client was recently widowed at age 50 after a 30 year marriage to an older man who had looked after her financially all her life. Financially unskilled, she has lost a lot of capital in the stock market and numerous mutual fund purchases.

The Questions

1. How could she stop the capital from more bleeding?
2. How can she get a guaranteed income?
3. Why did her husband not foresee these problems?

The Answers

The capital losses have eroded any hope that she can recover the funds which have been lost. Accordingly, she wants a safe harbour for her nonregistered funds which would guarantee her an income.

The Choices

She considered government bonds but was concerned about the possible changes in value. She considered real estate mortgage lending but soon felt herself out of her depth.

The Decisions

The easy answer - and the one she chose - was a series of life annuities with different companies commencing payments at different times.

Scenario #3: Balancing Income Needs with Family Interests

The Problem

How to balance the income needs of a widow with varying family interests.

The Facts

The client, aged 78, is a widow. Her husband left various properties and a business which is being managed by a son. And there are numerous other family members who inherited part of the estate.

The Questions

1. Should the widow distribute the estate immediately?
2. What about her concern about long term care facilities, so she can remain independent?
3. Is she better off to appoint a trustee to administer the various parts of the estate?

The Answers

The questions are easier to ask than the answers are to find. The family was divided by large age and social differences as well as by wealth.

The Choices

She wanted the family to stay together as much as possible, so she had really no choice but to take everyone’s interest to heart.

The Decisions

She carved out sufficient funds for herself for a large annuity which will be sufficient for long term care home payments if necessary. The problem of the estate balance was turned over to an independent trustee to be resolved.

Scenario #4: Maximizing Income for People with Health Problems

The Problem

A progressive lung disease has diminished the life expectancy of a 60 year old husband.

The Facts

There is no medical recovery possible in this case; death will ensue as the disease progresses.

The Questions

How to ensure that his wife will receive continual financial support during and after his death?

The Answers

Due to his disease it was decided to apply for a joint life annuity on an impaired basis. This involved submitting medical reports to the insurance company, attesting to the ravages of the disease.

The Choices

There was no other choice in this case as not a lot of money was involved and his widow-to-be is unskilled financially.

The Decisions

It was decided to apply for a joint life annuity and medical reports were submitted in support of the impaired life annuity application. Although he was 60, the underwriter rated him, from the mortality tables, as aged 64. As a result, he was able to boost his income about $90 per month.

Scenario #5: Making Certain That Income Continues For Life

The Problem

Guaranteeing income for a surviving wife.

The Facts

A 71 year-old man with a younger wife who does not wish to be involved in investing.

The Questions

1. What is the possible chain of events if he died first and his wife was left to handle the investment decisions for his RRIF each year or when necessary?
2. Where can he find a better return than low GIC rates, but secure regular monthly payments?

The Answers

If he dies now, his wife would need to continue with the RRIF and the investment choices already made, or buy an annuity.

Alternatively, he could buy a joint life annuity with payments guaranteed for both their lifetimes. One of the RRIF’s is earning 3% while he is forced to withdraw 7.38% this year and more the next years. Thus his capital is depleting each year which will eventually totally deplete the RRIF.

The Choices

Due to his wife’s unwillingness and inability to handle investments there was only one choice.

The Decisions

A joint life annuity was purchased to guarantee the income for them both.

Turning 71

Your Registered Retirement Savings Plans (RRSPs) must be converted to one or more of the following retirement income options by the end of the calendar year in which you turn 71.

• An Annuity
• A Registered Retirement Income Fund (RRIF)
• A lump-sum cash withdrawal

Registered Retirement Income Funds (RRIFs)

These work like an extension of your Registered Retirement Savings Plan, or RRSP. Your investments continue to grow tax-free but you must stop contributions and withdraw a certain amount of income from your RRIF each year.

RRIF Advantages

• You retain personal control over your investments
• Flexibility to change your income and make lump sum withdrawals

RRIF Disadvantages

• You could outlive your RRIF
• Income requires on-going management
• Depletes your capital if the amount you have to withdraw, exceeds the amount you are earning on the deposit

Assuris: Protecting Your Annuity Plan

Assuris is the not-for-profit organization that protects Canadian life insurance or annuity policyholders if their life insurance company should fail.

The role of Assuris is to protect policyholders by minimizing the loss of benefits and ensuring a quick transfer of their policies to a solvent company, where their protected benefits will continue. Every life insurance company authorized to sell insurance policies in Canada is required by the federal, provincial and territorial regulators to join Assuris.

About Assuris

Established in 1990, Assuris is designated by the federal Minister of Finance under the Insurance Companies Act of Canada, and specified in the "Quebec Règlement d'application de la Loi sur les assurances".

Are You Protected by Assuris?

If you are a Canadian citizen or resident, and you purchased a product from a member life insurance company in Canada, you are protected by Assuris.

How Does Assuris Protect You?

If your life insurance company fails, your policies will be transferred to a solvent company. Assuris guarantees that you will retain at least 85% of the insurance benefits you were promised and 100% of annuity payments up to $2000 a month for each annuity policy with different companies. Insurance benefits include death benefits, health expense benefits, monthly income benefits from annuities, and cash value in permanent life insurance policies. (Update: As of May 25, 2023 Assuris guarantees that you will retain at least 90% of the insurance benefits you were promised and 100% of annuity payments up to $5000 a month.)

Assuris’ Protection for Annuities

Assuris guarantees that you will receive up to $2,000 per month or 85% of the promised Monthly Income benefit, whichever is higher. (Update: As of May 25, 2023 Assuris guarantees up to $5,000 per month or 90% of monthly income benefit.)

What about multiple annuities?

If your capital will provide you with an income in excess of $5,000 a month, it is advisable to use 2 or more companies. If, for example your capital would provide $6,000 a month, then sufficient money to buy a $5,000 a month income should be transferred to one company and the balance to the next highest paying institution.

Thus you will have full 100% coverage for your income. And that applies to joint annuitants with non-registered funds also. In this instance, 2 polices can be taken with the highest paying company, by naming each person as a prime annuitant in separate policies. And some clients take a mix of long term single annuities with a joint life annuity with a zero guarantee. This ensures income for life and the highest income.