A buyer’s guide to annuities

Zoomer | January 1st, 2006

So you’re interested in buying an annuity to supplement your retirement income. You just aren’t sure which kind to get.

Here’s a quick Buyer’s Guide we’ve prepared that may help.

For starters, you need to know that annuities come in two basic types, life and term-certain annuities, which in turn are composed of a variety of forms that have appeal in specific situations. Let’s look at each in turn:

1. Life Annuity.
Life annuities are sold only by life insurance companies, which also sell RRIFs, LIFs, and other forms of annuities. A life annuity is described exactly by its name — the monthly payments, which are the highest of all annuities, keep coming as long as you live. But they stop the day you die, whether that date is a few months after you take it out or if you live well past your 100th birthday.

Few people opt for a life annuity these days. In fact, because of the relinquishment clause, which provides the possibility of losing all your money in the event of an early death, most insurance companies actually require you to sign a waiver stating that you understand and accept that payments cease when you die.

However, a life annuity othis variety would be suitable for people who do not want to manage their investments, who do not have families or charities they wish to favour with a bequest, and who want to receive the largest monthly cheque possible.

Life annuities that have one or more options are much more common and popular. The following are common types of life annuities that offer various additional features:

Joint-and-Last-Survivor. This variation pays less per month, usually between 10 and 15 percent less, but continues payments as long as you or your spouse lives. The payments stop when the surviving spouse dies. This annuity clearly appeals to married couples. An additional feature allows you to choose to provide the survivor either with the full amount at once or with payments over a defined length of time.
Guaranteed-Term Annuity. Either form of life annuity can be purchased with a minimum number of payments guaranteed. This ensures that any payments remaining or their “commuted value,” meaning the equivalent lump sum of future payments under the guarantee period, are paid to your spouse or other beneficiary upon your death.

Payments do not cease at the end of the guaranteed period if you are still alive. They continue until your death or until the death of your spouse in the case of a joint-and-last-survivor annuity.

Most life annuities include guarantee periods. The longest is to age 90, and they commonly range between 5 and 20 years. You must decide on a guarantee period at the time you buy the annuity. Again, there is a cost involved.

The length of the guarantee period reduces your monthly payments. In most cases, however, the difference can be relatively minor. As in the case of RRIFs, wouldn’t you prefer to see at least some money go to your family rather than to that huge, anonymous life insurance company?

Insured Annuity. If you want to buy an annuity with the additional goal of preserving capital for your estate, this option is worth considering. In effect, it combines two insurance products, a life annuity with no guarantee period and a term-to-100 life insurance policy.

First, however, you must be in good enough health to qualify for the life insurance, and that means being able to pass a medical examination. Older people without serious ailments are often approved, so it’s worth a try, but buy the insurance first. Insured annuities work well for nonsmokers in good health, 65 or older, with at least $50,000 in non-registered investments.

The annuity guarantees income for life, and the insurance policy protects your capital, providing a probate-free and creditor-protected estate for your beneficiaries. The Supreme Court of Canada recently ruled that annuities issued as insurance contracts cannot be seized by creditors in the case of bankruptcy. This insurance does not apply to term-certain annuities issued by other financial institutions.

Here’s an example: You buy $100,000 in term-to-100 life insurance with a guaranteed, fixed annual premium to age 100. Shop around. Some insurance companies continue the coverage past age 100 until death, with no further premiums. Next, buy a life annuity for a lump sum of $100,000, in return for a monthly income for life. The policy and the annuity do not have to be purchased from the same firm; in fact, you’ll almost always get better deals on each product from separate companies. Insurance companies typically offer their best bargains on one product only.

The annuity provides you with income and the insurance restores the original $100,000 after your death. If you pursue this technique, choose your agent carefully. Annuity prices, the availability of such policies, and the premiums vary widely among insurance companies. You need an independent agent who will shop the entire market for you, and who will also pick a financially sound company. The last thing you need is for your insurer to expire before you do.

2. Term-Certain Annuity. A term-certain annuity differs from a life annuity in that it provides a fixed monthly income until the age of 90, rather than for your life. If you die earlier, payments continue to your surviving spouse until what would have been your 90th birthday. If your spouse is younger than you, you can base this form of annuity on his or her age, thereby extending the payment schedule. If you do not have a surviving spouse, the remaining payments are cashed out according to the insurance company’s commuted value formula and paid to your estate.

It is important to note that although a term-certain annuity to age 90 does pay more than a life annuity with a guarantee to age 90, the difference in the amount of the payout is small. The advantage of a life annuity is that it provides you with the security of knowing that you will have income if you live longer, so it would be a better choice in many cases.

Term-certain annuities are sold by life insurance companies, but, unlike life annuities, they are also offered by banks, trust companies, and investment dealers (which also sell RRIFs and LIFs). Mutual fund dealers and credit unions are limited to selling only RRIFs and LIFs.

Adapted from Gordon Pape’s 2000 Buyer’s Guide to RRIFs and LIFs, by David Tafler and Gordon Pape, published by Prentice Hall Canada