What Is A Prescribed Annuity

What Is A Prescribed Annuity? Why, that’s easy.

A prescribed annuity is a non-registered life annuity with a portion of its periodic annuity payments taxable for the duration of the annuity. See? Simple.

What do you mean, ‘What does that mean?’

Oh.

Oh, OK, let’s take a few steps back.

An annuity is a financial product you can buy which guarantees you a regular income. Usually, though not always, it’s an alternative to a pension for your retirement years. It’s been described as a way of guarding against outliving your wealth, by ensuring a regular income from the time you take out the annuity until you die – whenever that may be. You can buy an annuity from the likes of your life insurance provider.

Life Annuities

We said a prescribed annuity was a life annuity. What does that mean?

Life annuities, as the name suggests, give you a guaranteed income…for life. However long that life lasts. That means it has the whiff of a gamble about it, with the pleasurable notion that if you live past the point at which you regain all the purchase price of your annuity, you win!

Compared to the likes of insurances and pensions, where you don’t get a particular incentive to outlast the fund, with a life annuity, you do.

How does that work?

If you buy an annuity when you retire at 65, you choose the purchase price and the per-month income you get for that price is calculated. The amount of the regular income payment you get, like an insurance premium, depends on a number of things, such as:

• whether you’re male or female (no data is currently available on how non-binary annuity-buyers will fare)
• your age when you buy the annuity
• the amount of money you invest in the annuity
• the type of annuity you buy
• whether you have the option to continue payments to a beneficiary or your estate after you die
• the length of time you want to receive payments
• the rates of interest when you buy your annuity
• the annuity provider

Say you pay $200,000 for the annuity, and it’s decided that the sum can be released back to you at a rate of $1000 per month.

Clear so far? Pay up front and get a monthly income released like a drip-feed back to you. You go about your life, eating, drinking and being as merry as you can be on $1000 per month. Life is pretty sweet and everyone’s happy, including the insurance company. Why’s the company so happy? Because it’s taken an up-front payment from you, and assessed when you’re probably going to die. If you happen to find your way to Elysian fields before you use up all of that initial outlay… well, the company’s staff Christmas party is looking pretty good.

This is an…unorthodox way of thinking about it, but the annuity provider is essentially ‘betting’ you’ll die before you’ve used up the whole of your $200,000. You’re ‘betting’ you outlast the repayment threshold, Let us save you some math here. On these figures, getting $1000 per month, you’d hit that $200,000 threshold at the age of 82, just 17 years after you took out the annuity.

If you make it past the point when you’ve used up that initial capital investment of $200,000…your annuity provider is obliged to keep on paying you at the same rate. $1000 per month, punctually delivered into your account (for example. Actual payment periods can be monthly, 3 monthly, etc). Every payment period you live beyond that threshold, means you’re benefiting from your investment. If you sink your savings into your annuity, any remaining funds on your demise can be paid to your beneficiaries under a guarantee.

Most annuity providers offer options that allow payments to continue after you die. If you enter into a joint annuity, for instance, some companies offer a joint and survivor option, which continues to pay out as long as one of the annuitants is alive. Some offer a guarantee option – income payments would continue to be paid to a beneficiary if the annuitant died within a specific amount of time. Some annuity providers even offer a cash-back option. Usually, if you can get this option, it pays back the amount you paid for the annuity to your beneficiary.

These exceptions and options are by no means universal though, so be sure to have an experienced life annuity broker to shop around for the options that make you happiest.

• Click Here To Find Out How Much A Prescribed Annuity Will Cost

Life Annuity Buyers

Life annuities are especially attractive to people who find themselves in a high personal marginal tax bracket as they head into retirement.

Why are they attractive? Swings and roundabouts both. In the early years of the annuity, life annuities bring tax savings if you’re looking at those higher personal marginal tax rates.

You wouldn’t like to save on your tax bill? Of course you would. So life annuities can be attractive on the way in. Surprisingly, they’re one of those unusual propositions that give back to you on the way in and on the way out, too. As the annuity matures, you actually qualify for lower personal marginal tax rates than you did at the beginning. So in some respects, life annuities are the very embodiment of carrot and stick motivations. They bring you in with tax breaks, and they eventually deliver lower tax rates as a fundamental part of their operation.

Perhaps naturally enough, most Canadians distrust them utterly, and they’ve not been taken up with anything like the enthusiasm experts believe they justify.

Here’s the fun part. With a prescribed annuity, you get periodic payments that form an income stream. Those periodic payments consist of two elements – the principal, and the interest.

You’re going to want to read the next sentence several times.

Only the interest part of the periodic payment is taxable.

That means you pay less personal income tax on the interest portion from a prescribed annuity than you do on a non-prescribed one. And it also means you pay no tax on the principal element of the periodic payment.

Registered and Non-Registered Life Annuities

We also said a prescribed annuity was a non-registered life annuity. Registered? Non-registered? Who? What? Where? Why?

This is where things get a little complicated.

The reason you can only get a prescribed annuity as a non-registered life annuity is because that non-registration is fundamental as to how they work.

Registered annuities are registered with the Canada Revenue Agency (CRA). By virtue of being registered, they qualify as Registered Retirement Savings Plans (RRSP) and Registered Pension Plans (RPP). That automatically entitles them to tax sheltering advantages.

Non-registered annuities are bought with money that hasn’t been registered, and so doesn’t qualify for the RRSP and RPP tax-sheltering benefits. As such, they then qualify for tax advantages in their own right. Some of those we’ve already discussed – initial tax breaks on the way into the prescribed annuity, eventual lower tax rates within the annuity.

What was the tax thing again?

Prescribed annuities pay out regularly, but a portion of the payout is taxable. And the older you are , the less the tax.

So why isn’t everyone taking out prescribed annuities?

Well, prescribed annuities are not for everyone. If there’s no way on earth you’re likely to outlive your wealth, there’s no essential benefit to you in getting a prescribed annuity – or any annuity, come to that.

Some people prefer the relative safety of registered life annuities, and others don’t see the benefits of taking out a prescribed annuity if they’re not imminently faced with higher tax payments when they retire.

For those who qualify for them though, prescribed annuities can be a hidden and frequently neglected gemstone among financial products, offering you end-of-life income and security, in the certainty that you’ll never outlive your income.

• Click Here To Find Out How Much A Prescribed Annuity Will Cost