What you need to know about annuities now
Tax-efficient and guaranteed, annuities can be useful retirement-planning tools for investors worried about outliving their savings
By: PAUL BRENT
Date: October 28, 2016
Due to upcoming tax changes affecting the income of annuities purchased after the end of this year, annuities have been a hot topic as advisors and firms prepare for those changes.
Annuities can sometimes be overlooked as a financial product for Canadians in or approaching retirement, but just who are annuities best suited for?
Patricia Michon, assistant vice-president of guaranteed wealth product management with Sun Life Financial, says that annuities can be a great choice for clients who are looking for guaranteed income for life, those worried about outliving their savings or investors looking for a way to eliminate exposure to equity market and interest rate volatility.
“Annuities make a great foundation for a retirement plan,” says Ms. Michon. “They help cover basic living expenses and supplement other sources of guaranteed income, such as a client’s CPP (Canada Pension Plan) or defined benefit pension plan. As a general rule, it’s best if only a portion of a client’s savings is used to purchase an annuity to provide this basic stream of income.”
Annuities can also be a tax-efficient vehicle for non-registered funds, adds Ms. Michon. An annuity purchased using non-registered money may qualify for prescribed tax treatment.
“If a client buys an annuity with registered funds – from RRSPs, for example – they are taxed on the entire income from the annuity in the year they receive it,” she explains. “But if they buy the same annuity with non-registered funds, and the annuity qualifies for prescribed taxation, they only pay tax on a portion of the income they receive. Further, because prescribed taxation means a level amount of tax each year over the life of the contract, the taxable amount is predictable. This is helpful from a planning perspective.”
Alexandra Macqueen, a Toronto-based certified financial planner and author, agrees that buying a prescribed annuity with non-registered funds can be very tax-efficient.
“In fact, if you buy a prescribed annuity late enough in life, the income may be tax-free,” she says.
The amount of tax paid on a prescribed annuity will change as of 2017, because the Canadian Revenue Agency will be updating the actuarial tables used to calculate the taxable portion of annuity income to reflect the longer expected lifespans of Canadians. Buying a prescribed annuity before the end of 2016 will provide higher after-tax income than purchasing one in 2017.
It’s important for advisors to know the pros and cons of every product so they can present the right solutions to clients. It’s equally important for advisors to help their clients understand the pros and cons so they can make informed decisions when it comes to their investments, says Sun Life’s Ms. Michon. In the case of annuities, guaranteed money for life does come with a trade-off – clients cannot pull money out of an annuity once it is purchased. Annuities are not a cashable product – instead, you trade liquidity for a guaranteed income stream. Also, as with other fixed-income products, annuities have been impacted by the current environment of ultra-low interest rates.
“Today’s low-interest-rate environment has put strain on the annuity market,” explains Ms. Michon. “Compared with historic levels, guaranteed income has been reduced.”
Ms. Macqueen says that another factor when buying an annuity is that money cannot be passed on to heirs or charitable causes, unless a guaranteed period is selected and the client dies during that period.
“If you have an estate motivation and you want to leave money for your kids or grandchildren, you are less likely to buy an annuity, or you will buy a smaller annuity,” she says.
Taking all the attributes of annuities into account, Ms. Michon says that annuities remain attractive for many investors.
“Regardless of interest rates, advisors continue to recognize that annuities are an important part of clients’ financial plans – depending, of course, on their clients’ goals, priorities and risk tolerance,” she says.
Sun Life Financial’s 2016 Retirement Now Report revealed that 40 per cent of Canadians are concerned about having enough money to live comfortably in retirement. “That’s a lot of people with a big concern,” she notes.
“The main benefit that annuities provide is guaranteed income for life – all but eliminating this fear and the risk of outliving your money,” says Ms. Michon. “Unlike other market based investments, once an annuity is purchased, there are no ongoing investment decisions that need to be made. And as an added bonus, annuities also provide protection from equity market and interest rate volatility.”
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