Annuities
Purchasing an annuity is another eligible retirement income option you might consider when converting your RRSP.
What Is an Annuity?
In simplest terms, an annuity is a financial contract between you and an insurance company.
You deposit an amount of money with the insurer and, in return, receive guaranteed payments of a pre-determined amount that generally last for life.
Examples of annuities include the Canada Pension Plan (CPP), Old Age Security (OAS), and a pension paid from your workplace. Annuities are rigid but in return, you receive a fully guaranteed income vehicle.
Basic Features of Annuities
Although individual terms and conditions vary significantly, annuities share several common features.
Payment Amount
Regardless of the type of annuity you choose, the payment amount is based on three key criteria:
- the amount of capital used to purchase the annuity
- interest rates at the time of purchase
- your age (and your spouse's age if using a joint and last survivor annuity) at the time of purchase
Annuities are highly sensitive to the interest rate environment. The higher the rates at the time of purchase, the higher your payments will generally be. Conversely, the lower the interest rates, the lower your payments will generally be.
Payments are also usually fixed for life - a feature which offers added convenience and security for seniors who don't enjoy actively managing their investments, particularly during more volatile periods.
If you're worried about inflation, an option may be purchased to make annuities indexed, although these options often result in a reduced payout.
Payment Frequency
Payments can be received monthly, quarterly, annually or any other interval agreed upon by you and the insurance company. Payment frequency is also agreed upon at the time of purchase.
Taxes
With a registered annuity, you pay income tax only on the payments received each year.
The principal deposited with the insurer remains tax-sheltered until it is received as payment.
Other Considerations
When purchasing an annuity, you effectively transfer all of the risk of investing to the expertise of the insurer.
All annuities are different. Depending on the type of annuity you select, there may or may not be survivor or estate benefits attached. Review all of your options and select the one best for you.
Deferred Annuity
A deferred annuity provides for income at a future date.
By law, payments can be deferred to a maximum of 12 months after the purchase of an annuity in the year in which you turn 71 if an annual payment mode is chosen.
Deferred annuities are suited to those who don't require immediate income, but who wish to benefit from a high interest rate environment that translates into higher payments later on.
Impaired Annuity
An impaired annuity generally results in higher payments than those offered by other annuities.
It can, however, only be purchased by individuals who have medical evidence of a health condition that reduces their life expectancy.
Are Annuities for You?
Annuities can represent an important component in any retirement strategy, offering two powerful benefits:
Security
Regular income of a pre-determined amount that is guaranteed for life
Convenience
The freedom of no longer having to manage your investments. This transfers all of the investment risk from you to the insurance company.
Is an annuity for you? Consider these factors in your decision:
- your age
- need for a regular flow of retirement income
- need for occasional access to additional capital
- your ability and interest in actively managing your investments
- family and estate planning considerations
- concern over inflation
For many individuals, the decision to purchase an annuity can change over time as their personal situation changes, so keep this option in mind for later on.
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