Dear Mr. Hughes,
I recently asked for life annuity quotes for my parents aged 87, but I
received some information which appears to be wrong.
The amount was $200,000 of non-registered funds and my parents
wanted a monthly life annuity income or a term certain guarantee of 13 years to take them to age 100.
The income on the term certain annuity was less than the life annuity income which is to be expected, but the term certain annuity income would be taxable, but not the life annuity income. How is that possible?
Answer
To answer your questions, I must first set out the differences between a term certain annuity and a life annuity, with or without a guarantee period.
A term certain annuity for your parents could be purchased with a guarantee of 13 years to their age 100. This would be a non-prescribed term certain annuity where the monthly payments would be the same, but the amount of taxable income would differ each year.
On the other hand, a life annuity, with or without a guaranteed number of years, can only extend to their age 90. So, they could purchase a life annuity with no guarantee or a guarantee of 1, 2 or 3 years.
In the case of the term certain annuity, accrual taxation is based on the actual interest amount that is earned each year after expenses. This term certain annuity will last for the guaranteed period and has a tax schedule based on the anticipated interest each year. There are also other factors which are more complex to explain and beyond the scope of this reply and the writer.
In the case of the life annuity, the life annuity income is again level but with taxation that is prescribed. This means that the interest to be earned over the lifetime of the annuity, is divided by the expected lifetime of the annuitants and any guaranteed payments, which together creates the taxable portion.
Since your parents are over their actuarial life periods, the lifetime of the annuity is zero. So their ages are regarded as zero with zero anticipated payments. So the tax reporting is zero.
I hope this answers your question.