Understanding annuities (1)
While most Canadians have a vague knowledge of annuities, few people fully understand them. So in this two-part series, we’ll explain how they work and how they may be of use to you.
At its heart, an annuity is nothing more than a contract, purchased from an insurance company, with a sum of money. The insurer then returns regular payments of principal and interest to the annuitant (that’s you). The payments will be either level or increasing, based on your choice, and will be paid at regular intervals for either a specified period of time, or for your lifetime. But that’s about where the simplicity ends. Unlike other insurance products, annuities do not offer the “right of rescission”. That is the right to have the contract set aside during a short time period after it is signed. The insurer will also not permit any changes to the annuity once it has been issued. And there is a world of options and choices available to the annuity purchasers. It can seem daunting. Here’s an overview of the more important features.
How many lives?
An annuity can cover a single life, or two lives. The payments derived from a single life annuity will be based on the agof the annuitant, the type of life annuity selected, and its features. Alternatively, a life annuity may be a “joint and last to die” annuity, based on two lives. In this case, the income is paid to one annuitant until death (the first death), and then to the survivor until his/her death. Obviously two people taken together will have a longer life expectancy than one, thus the annual income from the annuity will be lower.
When the annuity takes effect
There are a couple of choices as to the start date of annuity payments. You may select an “immediate annuity”, in which a lump sum is turned over to the insurer, and payments start immediately. The “immediate annuity” does not have what is referred to as an “accumulation period”.
With a “deferred annuity”, a single deposit, or a series of periodic deposits, are made during an accumulation period, and earn interest or some other type of investment income. Generally, since 1990, the accumulating income in a deferred annuity is taxable annually during the accumulation period, unless the money is in a registered plan. Upon the annuity’s maturity, the payments commence. Other things being equal, the payments in the case of a deferred annuity will be larger, given the opportunity for growth of the amount invested.
Annuitants can select a payment schedule that best suits them. Payments can generally be monthly, quarterly, or annual. Once the payment period has been selected, however, it is fixed.
In part two we will look at registered annuities, prescribed annuities, annuity terms and taxation issues.