Understand annuities

Now let’s look at some other key issues relating to these useful but little-understood retirement income options.

There are two types of annuities: “term certain” and life. With term certain annuities, the insurance company pays the annuity either for a specific time period, such as five, 10 or 20 years, or until the annuitant attains a specified age, such as age 90.

Life annuities, on the other hand, contain a mortality element and are actually a form of life insurance. They actually provide the annuitant with protection against the risk of outliving their assets. The older the annuitant is when the life income starts, the larger the income will be,

because the return of capital takes place during what is expected to be a shortened lifespan. A life annuity can offer a minimum guaranteed period. If death occurs during the guaranteed period, the insurance company will continue to make payments to the designated beneficiary, until the guarantee period expires. But the longer the guarantee period, the lower the annuity

income. If death occurs after the guaranteed period ends, the insurance company pays nothing more/P>

Annuitants who are fortunate enough to live beyond the average life expectancy will receive more than those who do not. Those with shortened life expectancy, as a result of health problems, may be eligible for what is known as an “impaired annuity” with a more favourable payment schedule.

You can buy either a registered or a non-registered contract, depending on where the money is coming from. Registered annuities would be bought with funds that come from RRSPs, registered pension plans (RPPs), deferred profit sharing plans (DPSPs), and the like. Provincial pension regulations require some further specific treatment for these funds. For example, mortality rates that have no regard to the annuitant’s gender must be used for all funds coming from an RPP, a locked-in RRSP, or a locked-in retirement account (LIRA). These regulations also generally require that the survivor of a “joint and survivor” annuity receive a benefit of not less than 60% of the deceased’s payment. Like payments from a RRIF, the full amount of payments received from a registered annuity is to be included in the annuitant’s income for tax purposes.

Non-registered annuities are purchased with money that has not received the tax sheltering advantages of an RRSP, RPP, etc. As a result, they qualify for certain tax advantages in their own right.

If you remember how a mortgage works, you’ll understand a non-prescribed annuity. It is subject to tax treatment in the same manner as a mortgage investment is. The interest income alone is taxable, not the portion that is return of principal. You may also recall that the interest portion of your mortgage payments is larger in the early years, and smaller in the later years.

A prescribed annuity, on the other hand, receives some special tax treatment. As with a non-prescribed annuity, the return of capital is not taxed. However, the interest that is included in the annuitant’s income is afforded special treatment. It remains level throughout the term of the annuity. So, therefore, does the tax impact on the annuitant. Factor in the time value of money, and this tax treatment is especially favourable to the annuitant when compared to the tax treatment of a non-prescribed annuity.

Along with the preferred tax treatment go a few other restrictions. Only individuals may own a prescribed annuity contract, and the policy owner and the annuitant must usually be the same person, although the policy owner may also be a spousal or testamentary trust. The annuitant cannot surrender or commute the annuity, except on death. If the contract is “joint and last to

die”, the annuitants must be either spouses or siblings (brother or sister). The total of the annuitant’s age plus any guarantee period cannot exceed 91. Lastly, payments must be level.