What You Need to Know About Annuities in Canada
When Canadians give thought to their retirement income options, what comes to mind? Chances are, they think of government-sponsored pensions like the CPP and OAS, RRSPs and RRIFs, or perhaps their employer pension plan. Nowadays, TFSAs can also be included in the conversation. But there are other options when it comes to funding your retirement, one of which we’ll cover here in this article.
What Is an Annuity?
It’s safe to say that annuities are not on the minds of most Canadians when they consider how they’ll fund their retirement. In fact, they may fall somewhere below winning the lottery or receiving an inheritance. That’s unfortunate because annuities can be an ideal source of retirement income for a lot of people, especially those who won’t benefit from a well funded, employer pension.
An annuity provides a guaranteed retirement income, through a contract purchased from a life insurance company, or from a financial advisor who is licensed to sell life insurance. Annuities are similar to an employer defined benefit pension plan in that the benefit the annuitant will receive is established from the outset, and guaranteed for life. Annuities can be purchased with funds from an RRSP, RRIF, or a non-registered account.
Types of Annuities
There are various types of annuities available to Canadian investors, with each one offering an array of options, making for a rather complex product. The most common are Life Annuities, and Term-Certain annuities. Let’s take a closer look at each.
The most common form of annuity is a life annuity, which is just as it sounds, in that it’s designed to pay you a monthly income for the remainder of your life. In most cases, payments will cease upon death, however, you can select options that will direct payments to your spouse should you pass away. The cost of the annuity, and/or the income you receive, will vary depending upon which options you choose, so you really want to do your homework to make sure it’s the right type for you and your family.
A term annuity provides a set income amount for a predefined time period, often ten or twenty years. If you happen to pass away prior to the end of the annuity term, the payments would continue, but be forwarded to your estate.
Life Annuity Illustration
As mentioned, annuities can be complex, but for the purpose of this illustration, I’ll keep things simple, to give you a basic idea of how a life annuity works.
For starters, let’s assume that a $100,000 life annuity is being purchased by a 60-year old male (the numbers will vary depending on factors such as age, sex, and the annuity amount). Doing some quick research, I’ve uncovered the following monthly income rates from several Canadian insurance companies, for a $100,000 annuity (registered funds):
- Company – Monthly Income
- BMO Insurance – $433.17
- Canada Life – $424.55
- Empire Life – $430.93
- Great West Life – $424.55
- Sunlife – $407.91
As you can see, the monthly amounts vary, so it’s really important that you shop around before settling on a specific company. Twenty or thirty bucks a month may not seem like a lot, but when it’s for the rest of your life, it can add up.
Let’s consider this for a moment. Using the BMO Insurance rate of $433.17/month on $100,000, it seems as though it would equate to a return of 5.2% per year ($433.17X12=$5,198.04/$100,000). Not bad. The problem, however, is that if you die, you don’t get the $100,000 back, nor does your estate.
So, while 5.2% seems a whole lot better than earning 2% on say, a GIC, with the GIC you would get your principal back when the term expires, or you pass away. With the life annuity, only if you outlive the entire $100,000 payback will you really get your money’s worth. In other words, you’re paying a premium for the guaranteed lifetime income promised by the annuity. It’s a formula that will work out better for some than others.
Advantages of an Annuity
Annuities are a good fit for someone who has enough savings to purchase one but lacks the guaranteed income provided by an employer pension plan. An annuity can offer much-needed peace of mind, knowing that the income will always be there. It’s hard to put a price tag on that reassurance.
Related to this, another advantage of purchasing an annuity is that it removes something called longevity risk. That is the risk that you will outlive your investments in retirement. With other retirement vehicles, such as an RRIF or a non registered account, it’s possible to deplete your nest egg at any time, leaving you with a shortfall of funds.
Who Won’t Benefit From an Annuity
Annuities aren’t right for everyone. If you already have retirement income that’s sufficient to cover your day to day expenses, then you’re most likely better off investing your money elsewhere. An example would be someone who has a very generous employer-funded pension, or more than enough savings to fund their retirement. In these situations, you may want to steer additional funds
into market investments that offer higher growth potential, along with improved liquidity.
Additionally, if you’re in poor health, you’ll want to steer clear of purchasing an annuity. No one is guaranteed any number of years in this life, but if the chances of you living long enough to benefit from the annuity payments aren’t great, then you’re better off keeping your funds liquid, in order to leave a lump sum behind for your heirs.
How Do I Purchase an Annuity?
I alluded to this earlier, but an annuity is purchased through a life insurance company. Most people will buy them through an in-person meeting with a life insurance agent or broker. Nowadays, there are options to do this over the telephone, or online. Some investment companies also have the ability to sell annuities, but the advisor would need to be licensed to sell life insurance.
Are There Downsides to Buying an Annuity?
The short answer is yes. Perhaps the biggest downside is the fact that they’re locked in. In other words, once your annuity is set up, you can’t make changes to your payments. Not only that, but you have no access to your funds should you require a lump sum of money. Because of this, you need to ensure that you have other resources available if you decide to make a major purchase, or should a financial emergency arise. That’s why it’s so important to do your research before making a commitment. Another downside is the cost. Make no mistake, life insurance agents make very healthy commissions from the sale of annuities, which ultimately is coming from the investor’s pocket. In the current era of ultra low fee investment options, such as robo-advisors and exchange traded funds (ETFs), annuities are priced at a premium.
Is an Annuity Right For Your Retirement?
Annuities can be an important part of your retirement plan, but the key is to think of them as a component of a larger strategy, and not the entire strategy itself. It’s important to own various asset classes, from safety and income investments, while maintaining a growth component through the markets. It’s never too early to plan for your retirement, and annuities are an option that shouldn’t be overlooked.