Common Annuity Terms and What You Need To Know

To better understand how annuities are bought and used in Canada, it is necessary to understand the different terms used in reference to annuities. Broadly speaking, Canadians can purchase annuities using either registered funds or non-registered funds.

Funding An Annuity

1. Registered Funds

Registered funds generally originate from registered retirement savings plans (RRSP’s), the major tax sheltered retirement vehicle that is registered with the Canada Revenue Agency. You transfer money to the insurance company from a registered retirement savings plan (RRSP), a registered pension plan (RPP), a specified pension plan (SPP), or from a RRIF, LIRA and other registered plans.

• Registered Retirement Income Fund (RRIF)

A fund established with a carrier and registered with the Canada Revenue Agency. Property is transferred from a registered plan such as an RRSP or RPP from which the RRIF makes payments to you. 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.

• Registered Pension Plan (RPP)

A type of trust registered in Canada that provides pension benefits for the employees of a company upon retirement. They are usually an arrangement by an employer or union to provide pensions in the form of periodic payments.

• Specified Pension Plan (SPP)

A pension plan or similar arrangement that has been prescribed under the income tax regulations as a specified pension plan for the purposes of the income tax act (currently the Saskatchewan pension plan is the only arrangement prescribed to be a specified pension plan).

• Registered Retirement Savings Plan (RRSP)

A retirement savings plan registered with the government to which you contribute. Any income or interest you earn in an RRSP is exempt from tax as long as the funds remain in the within the plan. You have to pay tax when you receive payments from the plan.

• Locked-In Retirement Account (LIRA)

This is a Canadian investment account designed specifically to hold locked-in pension funds. The distinction between a LIRA and RRSPs is that, where RRSPs can be cashed in at any time, a LIRA cannot.

2. Non-Registered Funds

You can also purchase annuities with non-registered funds. You can use any money that is not already in an RRSP, RPP, SPP, RRIF, or other registered plan. If you use non-registered funds, you will receive a higher pay-out than you would with registered funds as the payments are only partially taxable. Non-registered annuities can be either non-prescribed or prescribed.

• Non-prescribed annuities

Payments from a 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.

• Prescribed annuities

These are annuities that are exempt from accrual taxation and all growth is exposed to tax annually. 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. Non-registered prescribed annuities are one of the most tax efficient sources of guaranteed income.

Annuity Types

• Single Life Annuities

A single life annuity provides an income as long as the owner, or annuitant, is living. When the annuitant dies, the income stops, unless the owner has opted to have a minimum guarantee period, which guarantees that the income will continue for a minimum number of years from the time the income starts.

• Joint Life Annuities

In order to offer maximum security, joint life annuities provide income payments for the lifetime of a primary annuitant and that of a second annuitant (usually a spouse). Income payments may continue to the survivor in the same amount, or in a predetermined reduced amount. A joint life annuity provides you with regular income payments for your lifetime and for that of your spouse, partner, or other person you select. With registered funds, the life annuitants must be spouses, but not with non-registered funds. Payments may reduce on either death. Neither annuitant can outlive the payments.

The guaranteed period may be for any term from zero to 40 years for non-registered funds and up to age 90 for the youngest annuitant in a registered annuity. Non-registered annuities are used to provide guaranteed income, especially where there is no company pension being paid. If the beneficiary is not the spouse of the annuitant in a registered annuity, any remaining payments must be commuted. Payments in any registered annuity may continue for the balance of any remaining guarantee period to a qualified recipient such as a spouse.

• Term Certain Annuities

Also known as Fixed Term Annuities, these products provide income payments only for a specific number of years. These payments are not contingent upon survival. The payments are made whether the annuitant lives to receive them or not. The minimum term for a term certain annuity varies with each company. The maximum term is 40 years. The purchase price is entirely independent of age. For registered funds, annuity payments must be guaranteed to age 90, minus the age of the annuitant.

• Term Certain Annuity for a Child

When a financially dependent child or grandchild receives a lump-sum payment from a registered retirement savings plan (RRSP) or registered pension plan (RPP) because a parent or grandparent has died, you can purchase an annuity on behalf of the child. The child is responsible for any tax payable on income from the annuity and the tax can be spread evenly over the time between the annuity’s purchase date and the day before the child’s 19th birthday.

• Instalment Refund Life Annuity

This option guarantees that if payments have started and the annuitant dies before receiving payments equalling the minimal premium paid, payments will continue to the beneficiary until the total amount of payments received equals the original premium. This feature is only available for single life annuities purchased with non-registered funds, and only available from certain companies.

• Indexed Annuity

An indexed annuity provides for annual increases in income to help offset the effects of inflation. Under this option, income payments increase on each policy anniversary by a fixed amount, such as 3 percent per year. Indexing is available for single life and joint life annuities, with or without a guaranteed period, and is available for both registered and non-registered annuities.

The above are the types of annuities that are generally enquired about, but not used very often. Whatever your situation, a company may consider the circumstances and issue what amounts to a custom-made policy.

• Impaired Life Annuity

Impaired annuities are specially designed for those suffering from serious health problems. This type of annuity will provide higher income payments than a standard annuity provided the annuitant qualifies for an age rating.

Occasionally referred to as “medically underwritten annuities,” impaired life annuities are custom annuities written for those with a shorter life expectancy than the average person. They are also referred to as “enhanced annuities.” Because a person in poor health has a shorter life expectancy, an impaired life annuity may be able to provide a higher monthly pay-out than a conventionally underwritten annuity.

• Integrated Life Annuity

Clients who wish to retire early can bridge the income gap between the time of their early retirement and the time they begin to receive benefits from their Canada or Quebec Pension Plan (CPP/QPP) and Old Age Security (OAS) -- which is normally age 65 -- by purchasing an annuity that blends in with other income.

At age 65, the income payments will decrease proportionately as your government benefits increase, resulting in a level income. If the level of pension increases before the annuitant reaches age 65, the annuity will not reduce. Only an annuity purchased with registered funds may be integrated with the OAS benefit.

• Cash Refund Life Annuity

This option guarantees a beneficiary will receive a lump sum equal to the difference between the original premium paid and the total payments received. This option is only available for single life annuities purchased with non-registered funds.

Guarantee Options

• Return of Premium Guarantee

This option can guarantee a return of the original premium if the annuitant(s) dies before the first payment date. This option is often available if the payment start date is deferred.

• Single Life Annuity

The original premium will be returned to the named beneficiary if the annuitant dies before the payment start date. Single life annuities provide the highest income, all things being equal, but income ceases upon the death of annuitant.

• Joint and Survivor Annuity

If registered funds are used and the primary annuitant dies before the payment start date, then the premium will be refunded to the joint annuitant. If non-registered funds are used, the premium will be refunded if both annuitants die before the payment start date.

• Guarantee Period

If a guarantee period is chosen, payments are guaranteed to be paid for the selected period as well as for life. If the last surviving annuitant dies before the end of the guarantee period, then payments will be made to the named beneficiary in the case of non-registered funds. The longer the guarantee period, the lower the income amount is.

• Commuted Value

If, after the death of the annuitant, any guaranteed payments remain, the named beneficiary may choose to continue to receive the payments or to take a lump sum payment. If the funds are registered and the named beneficiary is not the spouse of the annuitant at the time of death, any remaining income payments must be commuted to a lump sum. Payments may continue if the amount is non-registered.

Other Terminology

• Annuity type and Options

The type of life annuity and any guarantees you choose.

• Annuitant

The person on whose life expectancy the policy is based. For Term Certain Annuities the annuitant is the measuring life used to determine the length of the term certain period. The annuitant is typically the owner of the policy.

• Annuitization

Annuitization involves converting your accumulated retirement assets into a series of periodic payments that last for a period of time of your choosing, in accordance with the provisions of the annuity contract.

• Annuity

An annuity converts a fixed sum of money into a series of periodic payments that provide a regular source of income, usually during retirement.

• Beneficiary

The person designated to receive the death benefit payable on death of the annuitant, where applicable.

• Distribution Period

The period of time, either a specified number of years or lifetime, over which distribution payments are made to the annuitant. Earnings become taxable when the annuitant begins to receive payments. The pay-out during the distribution period is fixed.

• Interest Rates

Interest rates at the date of deposit, bond rates, etc.

• Mortality

This is your calculated or estimated life expectancy.

• Life Annuity

As its name implies, a Life Annuity provides income payments during the life of the annuitant.

• Single or Joint Life Annuity with a Guaranteed Period

Like standard Life Annuities, these products provide income payments for the life of the annuitant.

In addition, however, these annuities will guarantee that a certain number of income payments will be made, whether the annuitant lives or not.

Annuity Options

• Deferred Annuity

An annuity where the income payments begin at a specific date in the future. The advantage is the owner is able to lock-in interest rates today, even though the income is not needed until sometime in the future.

• Income Deferral

The period of time between the 'Purchase Date' and the 'Income Start Date'. Here income from the annuity is deferred for a period after purchase.

• Immediate Non-registered Annuities

A type of annuity where you make a one-time contribution and in exchange the insurance company immediately begins payments for life, or for a specified period of time. Regular payments can be received on a monthly, quarterly, semi-annual or annual basis. A portion of each payment represents taxable interest, and the other portion is a tax-free return of your principal.

• Indexed Annuity

Indexed annuities help to combat the effects of inflation by providing automatic income increases on an annual basis. These increases are made according to a predetermined percentage. You can choose annual pay-out increases in any amount up to 4%.

Maximizing Protection

• Using different companies

The prime annuitant (you) should consider splitting capital between the highest paying companies to gain the 100% insurance coverage.

• Applying for different annuitants

If the non-registered monies can be shared, consideration should be given to applying for policies, with different prime annuitants.

• 100% Income Protection

Assuris.com guarantees a policyholder up to $2000 per month income with each company.

• 85% Income Protection

If the amount of the monthly payment exceeds $2000, assures applies only 85% protection. Thus, if the income is $3000, then 85% of that amount i.e. $2550 is covered.

Payout Options

• Level Payments

Payment amount remains the same throughout the payment period.

• Indexed Payments

Income increases yearly by a fixed percentage

• Integrated Payment

Annuity income decreases when CPP, QPP or OAS payments begin.

• Reducing Payment

Income reduces by a certain percentage selected at issue when one of the annuitants dies.