Last updated: Dec-13-2018

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Fund Library Q&A
Your questions about financial planning, investments, and portfolio management answered by an industry expert

By Robyn K. Thompson  | Friday, May 19, 2017

Q – What are “annuities” and how do they work? – E.O.

A – When you purchase an annuity, you essentially buy a contract under which the issuing company (usually an insurance company) invests the lump sum you provide and guarantees a regular payout with interest over the life of the annuity contract. Typically, monthly annuity payouts are quoted per $100,000 of the contracted amount. Very simply, an annuity provides a guaranteed income stream for life. Annuities are sometimes used as an RRSP maturity option; however, annuities have been less popular for this purpose in recent years, owing to the historically low level of interest rates.

Types of annuities

There are several types of annuities, with various types of payout schemes. You can, for example, choose payments for a fixed number of years, or you might choose payments that last for the rest of your life, however long that might be. You can opt for monthly, quarterly, or semi-annual, or annual payments.

For example, a “Term Certain Annuity” guarantees an income for as long as you want, up to age 90. If you die before all payments are received, the balance will go to your estate.

Another option is a “Life Annuity,” which guarantees a regular income for as long as you live. However, payments stop when you die, and no money will go to your estate.

Many people who must choose an RRSP maturity option opt for some combination of an active RRIF portfolio and an annuity to continue providing growth, inflation protection, and a guaranteed income stream. Another option may be to invest a portion of your portfolio in an insurance product that offers a guaranteed income withdrawal feature.

This type of product, called a Guaranteed Minimum Withdrawal Benefit product is similar to an annuity in that it guarantees a specific regular monthly, quarterly, or annual payment until you pass away. But unlike an annuity, the guaranteed income stream could increase as the investments in your portfolio increase. You can cash out of this type of policy and take the “cash surrender value” if your situation changes dramatically and you need the cash. (But I do not recommend taking the cash out of this type of policy except as a last resort.)

Once you buy an annuity, of whatever type, you’re locked into its terms, and you won’t be able to change them.

Factors affecting annuity payout

Because annuities are ultra-conservative products, they are typically tied to the level of prevailing interest rates. And those rates have been ultra-low since 2008. Annuity rates have thus also been correspondingly low, making annuities a less desirable RRSP maturity option than RRIFs for the past few years.

Other factors that typically affect the annuity payment you’ll receive are your age and gender (the older you are, the higher your payments, and women typically live longer than men), the amount you deposit and the length of the term, and any options or riders you add to the policy (such as joint-and-last-survivor), which increase the insurance company’s costs.

Annuity income is not taxed if the policy is purchased with non-registered funds (that is, you’re buying it with after-tax dollars). Income from annuities purchased with RRSP or RRIF funds will be taxed at your marginal rate (you’re purchasing the annuity with dollars from registered funds that have not been taxed). A “Prescribed Annuity,” which levels out the interest and principal portion in each payment, is one way to defer the tax bill, at least in the early years of the annuity payout.

Not for the do-it-yourselfer

Annuities are complex products, and it is important that you understand how interest rates and other factors affect how much income you will receive. It may not be advisable to convert all of your RRSP into an annuity – this will depend on your investment objectives and risk tolerance. I recommend seeking the advice of your financial planner and/or a licensed insurance agent to discuss annuity options and how they might best fit into your overall retirement plan. – Robyn

Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at for a confidential planning consultation.

Notes and Disclaimer

© 2017 by the Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.

The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned are illustrative only and carry risk of loss. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.

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