Life annuities remain relatively unknown, especially among younger people, having long been neglected. But with interest rates now higher and the population aging, the ingredients for their return to popularity are now in place.
We recently received this question from Claire, a reader of Duty : “I am retired and would like to purchase an annuity soon, since guaranteed investment certificates (GICs) that I purchased in 2023 will soon expire. First, I would like to know if it is more advantageous to use a registered amount (in a registered retirement income fund) or a non-registered amount to purchase a life annuity (for life)? Also, since rates are falling, I would like to know up to what annuity purchase rate is it advantageous to purchase a life annuity? I was informed by my financial institution that the rate was 4.75% in June 2024 and 4.6% during the week of August 5.”
Tax treatment of the annuity
Annuities are financial products that are generally distributed by insurers and provide a guaranteed income. An annuity is considered registered if it is purchased with funds from a retirement plan, such as a locked-in retirement account (LIRA), a registered retirement savings plan (RRSP) or a registered retirement income fund (RRIF), for example. Otherwise, the annuity will be “unregistered.”
To answer our reader’s first question, we may ask ourselves which form of annuity is the most advantageous from a tax point of view. All annuity payments are subject to tax, although their treatment varies depending on the type chosen. In the case of registered annuities, the income is fully taxable, while for non-registered contracts, only the interest on the annuity income is taxable.
As for non-registered annuities, it may be a so-called prescribed annuity or not. It is the prescribed annuity that is to be favored. Although the amounts received are composed of capital and interest, these are in fact taxable in a level manner and spread over the entire duration of the contract. This therefore allows a form of deferral of the taxation of interest over time, which is undoubtedly more advantageous than the taxation of a GIC.
But for our reader, her choice must also be based on her actual withdrawal plan and her liquidity needs. From a tax perspective, the prescribed life annuity is more attractive than the registered annuity. But what is the balance in the non-registered account? Is it enough to buy an annuity that meets Claire’s needs? If the RRIF is already disbursed with more than the minimum withdrawals to offset the cost of living, the registered annuity could also be considered.
At what rate?
When asked about the most advantageous rate, I would answer our reader that the ideal way to buy an annuity is to use the services of a professional who has access to several insurers to compare the annuities offered. Each insurer establishes the rate used to calculate the annuity according to internal criteria, which can therefore vary.
If our reader’s question is whether the rate offered by her institution, namely 4.6%, is the right one or whether she should hurry up or wait in the hope that it will become higher, my answer may surprise you. An annuity should not necessarily be purchased on the basis of comparing a rate used with that of a GIC or with the return on an investment portfolio, for the simple reason that it is impossible to predict with exactitude the future return on these assets. It is essentially a means of securing a part of the assets and generating income intended to cover fixed expenses.
Purchasing an annuity protects against longevity risk. Thus, the profitability of the annuity can only be calculated retrospectively, when the date of death of the annuitant is known and the returns of other assets are comparable.
The real issue goes beyond the rate used to establish the annuity; it is Claire’s needs that matter here. In light of the information available, it is possible to think that the prescribed life annuity will be a priority over the registered annuity. It would be wise to seek good advice to determine whether this annuity should be reversible or not, or accompanied by a guarantee period. The choice of the type of annuity is crucial since once the contract is purchased, it can no longer be modified.
Financial planner, Sandy Lachapelle is president of the independent firm Lachapelle finances intelligentes.