Annuities present a vehicle for the investment and payout of money set aside for retirement.
Rather than being a simple savings investment with a date of maturity, an annuity has a defined income portion after the investment period or purchase, paying out the investment in a structured way, usually monthly, to provide steady retirement income.
“An annuity is an agreement between you and a financial institution under which you agree to invest a certain amount of money,” says Christopher Liddiard, certified financial planner with Investors Group in London, Ontario, “and the financial institution agrees to make regular payments to you after a certain date, for a defined period of time.”
While the basic principle is straight-forward, features of individual annuities vary.
Payout duration divides annuities into two fundamental types: life annuities that pay the purchaser until death, and term annuities that pay for a predetermined length of time, for example 10 or 20 years. In both cases, monthly payment amounts are guaranteed.
Costs of annuities vary, depending on type and other features. An equal amount invested in both life and term annuities usually finds the life annuity paying out less over a longer time.
Canadian income tax regulations cover annuities in Part III, Annuities and Life Insurance Policies.
The purchase of annuities — as part of a registered retirement savings plan, or during the conversion of an RRSP to a registered retirement income fund — carries the tax-savings advantages inherent in registered plans.
Annuities that are not part of registered plans may be subject to heavier tax burdens, unless these have prescribed annuity status, which allows for more favorable taxation under section 304 of Canada’s income tax regulations.
As a prescribed annuity is paid out, each payment includes both interest income and a return of capital. This strategy balances taxation by returning unprotected investment amounts early in the annuity.
Investment interest exchanges with investment capital as the money that earns growth later in the annuity, which is taxed as income and not as a capital gain, providing some tax sheltering outside of a registered retirement program.
Government Protection of Annuities
Selling and issuing annuities in Canada requires authorization under Canadian law, since one of the prime purposes of annuities provides for financial security of Canadians over time.
The Government Annuities Act and the Government Annuities Regulations made under the act set forth the definitions and operating principles for the issuance and control of annuities. Your annuity investments with life insurance companies are further protected through a not-for-profit organization called Assuris.
Funding for Assuris comes from the insurance industry itself, and has the endorsement of the Canadian government through the Insurance Companies Act of Canada.
Membership is required under law for all life insurance companies in Canada. In the case of failure of the company that holds your annuity, you are assured that at least 85 percent of its value is transferred to a healthy company.
Structured Settlement Annuities
Annuities are frequently part of injury settlements, such as those that occur after car accidents. To provide for and protect accident victims, the Canadian government introduced structured settlements to encourage the investment of settlement funds in secure plans.
These settlements can only be created with a court order or the consent of the insurance company paying a settlement amount. The investment itself remains under the ownership of the purchasing insurance company, but the payments are guaranteed to the settlement recipient.
Under sections 3 and 6 of the Income Tax Act, any income from damages or settlements is tax-free. In the case of a structured settlement, this includes gains through investment growth, so any income from annuities that are part of a structured settlement remains tax-free as well.
References & Resources
- Christopher Liddiard, B.A.; Certified Financial Planner; Investors Group, London, Ontario
- Justice Laws Website: Government Annuities Act
- Canada Revenue Agency: Damages, Settlements and Similar Receipts