An annuity is a financial tool which is designed to provide a steady stream of guaranteed income in exchange for a lump sum payment. It is a contract between an individual (or two individuals) and an insurance company which can be used to provide a reliable source of income during retirement.
In this blog post, we will discuss the basic principles of annuities, including the types of annuities, features, and additional benefits.
Types of Annuities
There are three main types of annuities available in Canada: single life annuity, joint life annuity and term certain annuity. Each type of annuity has its unique features and benefits which can be customized to suit your needs.
Single Life Annuity
A single life annuity provides a guaranteed income stream for the lifetime of the annuitant. The annuitant is the person who receives the income payments from the annuity and is typically the person who purchases the annuity with their own savings. The payments from a single life annuity are based upon one life, not two lives.
With a single life annuity, the income payments stop when the annuitant passes away and there are no further payments made to their beneficiaries or estate, unless there was a guarantee period purchased with the annuity.
Single life annuities are often purchased by retirees who are looking to supplement their retirement income as they provide a reliable and predictable source of income that is guaranteed for life. It is very common for Canadians to use a single life annuity to top up Canada Pension Plan and Old Age Security so that the individual has a set amount of retirement income guaranteed for life.
Joint Life Annuity
A joint life annuity provides a guaranteed income stream for the lifetime of two annuitants. The annuitants are the individuals who receive the income payments from the annuity. Since there are two people who are insured with a joint life annuity, the income payments do not stop upon the 1st death and are paid out until the 2nd death of the insured lives.
Upon the first death, the surviving annuitant will continue to receive the income payments from the insurance company. The percentage of the annuity payment that they will continue to receive will depend on how the annuity was structured at the time of purchase. The surviving annuitant can continue to receive 100% of the original payment, or it can be reduced to a certain percentage (e.g. 66% of the original payment). You can customize the amount that the surviving annuitant will receive which will have an impact on how much the annuity will pay out. The higher the amount that will go to the survivor, the lower the monthly payment will be.
Joint life annuities are purchased by couples in retirement who may be concerned about outliving their retirement savings. They can also help provide peace of mind for couples who may be in a situation where one person manages all of their investments and are worried that a surviving spouse may not be able to continue to take care of their retirement investment portfolio.
Term Certain Annuity
A term certain annuity provides a guaranteed income stream for a fixed period of time, regardless of market fluctuations or changes in interest rates. Currently, term certain annuities can only be purchased on one life and not joint with two people.
The annuitant is the person who receives the income from the annuity and chooses the length of time for which they want to receive payments. This is referred to as the “term” and typically ranges from 5 to 30 years.
The annuitant also chooses the payment frequency (monthly, quarterly, semi-annually, or annually) and the payment amount, which is based on the annuitant’s age, gender and the prevailing interest rates at the time of purchase. These payments are a combination of both interest and principal, with the interest portion being taxable as income.
At the end of the term, the payments stop and the annuity contract ends. If the annuitant dies before the end of the term, the remaining payments are made to the annuitant’s designated beneficiaries.
It is important to note that a term certain annuity is not the same as a life annuity. With a life annuity, the payments continue for the annuitant’s entire lifetime, regardless of how long they live. With a term certain life annuity, the payments only continue for the specified term, after which they stop.
Indexing
Indexing with annuities refers to a feature that some annuities offer which allows the annuity payments to increase each year to keep pace with inflation. This is important because without inflation protection, the purchasing power of the annuitant’s income could decline over time which can make it difficult to maintain their standard of living.
In Canada, you must select a percentage between 0% and 6% if you want to add indexing to your annuity. The percentage of the indexing increase is added to the annuity payment each year which increases the overall income received by the annuitant. Unfortunately, life insurance companies in Canada do not offer indexing which is attached to Consumer Price Index (CPI).
Indexing with annuities can be a very valuable feature, especially for those who anticipate a long retirement or who are concerned with the recent high costs of inflation.
Guarantee Periods
A guarantee period is an optional feature that ensures that if the annuitant dies before the end of the guarantee period, the remaining payments will continue to be made to the annuitant’s beneficiaries for the remainder of the guarantee period. If the annuitant outlives the guarantee period, the annuity payments will continue for the annuitants lifetime, regardless of how long they live.
The guarantee period is a fixed length of time which typically ranges from 5 to 30 years and is selected at the time of purchase. The cost of the guarantee period is factored into the annuity premium, so annuitants should expect to pay a higher premium for an annuity with a longer guarantee period.
Guarantee periods are a great way to put an insurance wrapper around your initial investment. It can be very difficult for some to hand over a lump sum amount of money to the insurance company for the purchase of an annuity. The guarantee period allows you to ensure that you receive a minimum amount of years of payments in the event that you pass away before the end of the guarantee period.
It’s important to note that while a guarantee period can provide added security and protection for beneficiaries, it can also reduce the amount of income that the annuitant receives during their lifetime. The longer the guarantee period, the lower the annuity payments will be. Therefore, annuitants should carefully consider their personal financial needs and goals when selecting a guarantee period for their life annuity.
Conclusion
Annuities can be an attractive option for Canadians who are looking to secure a guaranteed income stream in retirement. With so much unpredictability in today’s world of investing, annuities can provide peace of mind for many retirees to ensure that they have a reliable source of income for life. The additional benefits available allow the annuitant to customize the structure of the annuity to ensure that they are able to meet their specific needs.
When considering an annuity, it’s important to carefully assess personal financial goals and needs, compare different products and providers, and understand the costs and risks involved. Annuities can be an effective tool for building a secure retirement plan with the right guidance and information.
Please reach out to us at Life Annuites.com to discuss your annuity options further. We can also run customized quotes from the top life insurance companies in Canada for you at no cost.
