What annuities are
An annuity is a financial product that provides you with a guaranteed regular income. Typically, it’s used during your retirement and sold by an annuity provider, like a life insurance company.
How annuities work
You can buy an annuity with a lump sum or through multiple payments over time. The income payments you receive from an annuity are a combination of 3 things:
- interest
- a return of your capital
- a transfer of capital from annuity holders who die earlier than statistically expected to those who live longer than expected
You may choose to either receive income payments for a fixed period or for as long as you live. Depending on the type of annuity you choose, you may receive income payments at different frequencies:
- monthly
- every 3 months
- every 6 months
- once a year
You may choose to start receiving your payments right away. You may choose to receive them later if you bought a deferred annuity.
The amount of the regular income you get depends on multiple things:
- your gender
- your age and health status when you buy the annuity
- the amount of money you invest in the annuity
- the type of annuity you buy
- whether you have the option to continue payments to a beneficiary or your estate after you die
- the length of time you want to receive payments
- the rate of interest when you buy your annuity
- the annuity provider
Types of annuities
There are many kinds of annuities. It’s important to understand each type of annuity and their options, benefits and risks.
Before you buy an annuity, you need to determine if:
- you want the annuity to continue to be paid to a beneficiary after you die
- you want regular income payments or payments that will increase or decrease regularly
Life annuity
A life annuity provides you with a guaranteed lifetime income. For example, suppose you buy a life annuity for $100,000 at age 65. You have an income of $500 per month, you’ll get your $100,000 back by age 82. If you live past 82, you’ll still receive $500 per month as long as you live.
As this table shows, the longer you live, the more income your annuity provides.
In most cases, your life annuity payments stop when you die. No money goes to your estate or named beneficiary.
Certain annuity providers offer the following options so that payments continue after you die:
- a joint and survivor option: income payments continue as long as one of the annuitants is alive
- a guarantee option: payments continue to be paid to a beneficiary or your estate if you die within a specific period
- a cashback option: provides a one-time payment to a beneficiary or your estate if you die before receiving a specific amount of money. The amount is usually what you paid for your annuity
You can combine these options, but each additional feature will lower the amount of your payment.
Term-certain annuity
A term-certain annuity provides guaranteed income for a fixed period (term). If you die before the end of the term, your beneficiary or estate will continue to receive regular payments. They may also receive the balance of the regular payments as a lump-sum.
This table shows that your regular payment is usually lower when you choose a longer guaranteed payment term. The longer your annuity term, the more money you or your beneficiary will make on your original $100,000 investment.
Variable annuity
Providers of that type of annuity invest your money in products with a variable return, such as equities. You receive a fixed income and a variable income. The fixed income is usually lower than what you would earn with a non-variable annuity.
The variable income you receive will vary based on the return of the investment. You may earn more money if the investments perform well, and less money if they perform poorly. Non-variable annuities make guaranteed income payments, regardless of the return.
Comparing different types of annuities
Annuities offer different options, review the pros and cons of each.
Life annuity
A life annuity provides you with a guaranteed lifetime income.
Pros
- guaranteed income payments for as long as you live
- no risk of outliving your income
- additional joint and survivor option to transfer payments to your spouse/partner
- additional options to provide money to your beneficiary or estate when you die
Cons
- you may die before receiving all of your money back
- adding options usually means a lower regular payment. For example, providing payments to your spouse when you die
Term-certain annuity
A term-certain annuity provides guaranteed income payment for a fixed period.
Pros
- guaranteed income for a set period
- your beneficiary or estate will receive any remaining benefit if you die before the end of the period
Cons
- you may live longer than the term of your annuity. This means that you could stop receiving income before you die
Variable annuity
A variable annuity is when the provider invests your money in products with a variable return, such as equities.
Pros
- fixed income plus potential extra income linked to market performance
- you may earn more money than a non-variable life annuity if the investments backing the variable portion of your annuity perform well
Cons
- your regular income is harder to predict
- you may earn less money than a non-variable life annuity if the investments backing the variable portion doesn’t perform well
What to consider before buying an annuity
Before buying an annuity, take the following into consideration.
When to buy an annuity
The best time to buy depends on your financial needs and sources of income.
For example, you may want more money early in your retirement to pay for travel or hobbies. You may also want more income later in your retirement to pay for health care or accommodations.
If you want more money later you may consider waiting to buy an annuity, or deferred annuity. This product allows you to pay for the annuity ahead of time and to start receiving payments later. Deferred life annuities provide higher regular payments than immediate life annuities. This is because you’ll receive fewer payments during your life.
You may buy an advanced life deferred annuity with money from your employer pension plan or your registered retirement savings. In this case, certain tax rules apply in terms of age and amount limits.
Learn more about the tax rules for advanced life deferred annuities.
Your other sources of retirement income
You may have multiple sources of retirement income.
This may include:
- employer pension plan
- Pooled Registered Pension Plan (PRPP)
- registered savings, such as a Registered Retirement Savings Plan (RRSP) or a Tax-Free Savings Account (TFSA)
- public pensions and benefits, such as Old Age Security (OAS), Canada Pension Plan (CPP) or Quebec Pension Plan (QPP)
- personal savings and investments
Having an annuity can make it easier to create a budget and manage your money. It’s especially the case if it’s your only regular source of retirement income.
However, an annuity is not always the best option for you. Your regular income and savings may already cover your expenses when you retire. Talk to a financial professional to determine if you’ll have enough money for your needs when you retire.
The overall price of an annuity can vary between providers
Annuity providers may offer you different income payments for the same type of annuity.
Providers calculate the monthly payment amounts they can provide based on many factors:
- the type of your annuity (fixed or variable)
- the term of your annuity (life-only, joint life, term-certain)
- your age and gender (to estimate your life expectancy)
- their operating costs
- the expected return on their investments
Before buying an annuity, ask for the list of fees and commissions. Make sure you understand the contract restrictions, including penalties and administrative fees.
Once you know what kind of annuity you’re interested in buying, compare similar products from several providers.
The option to leave money to a beneficiary or your estate
You may decide to leave money to your estate or a beneficiary when you die. If so, you could consider buying a term-certain annuity or a life annuity. You may add a joint and survivor option or a guaranteed payment period.
Buying an annuity is not the only option. For example, you can also keep some money in another product, like a savings account, TFSA or RRIF.
You may lose money
You’ll receive more money from a life annuity the longer you live. However, you may not live long enough to get the money you paid for the annuity.
Annuities may require a large investment
Buying an annuity can be expensive. For example, many annuity providers may ask that you invest $50,000.
Tax implications on annuities
You'll have to report the income you get from an annuity when you file your taxes. The income amount may be taxable. The amount of tax you may pay will vary depending on the product. Taxes will be different if you buy your annuity using registered savings versus non-registered savings.
Learn more about taxes and annuities.
How your annuity income is protected
Canadian life insurance companies have to be members of a consumer protection agency called Assuris. Assuris protects policyholders up to a certain amount if the annuity provider is unable to pay. You’ll then continue to receive at least some of your money if your provider goes out of business.
The income you receive from an annuity covered by Assuris is insured as follows:
- 100% for monthly payments up to $5,000
- 90% for monthly payments above $5,000
For example, if your regular annuity income is $3,500 per month, you’ll continue to receive the full amount. If your regular annuity income is $6,500 per month, you’ll receive 90% of this amount which is $5,850.
Find the list of insurance companies that are members of Assuris.
Changing or cancelling an annuity
When you buy an annuity, you sign a contract with the annuity provider. Typically, once you buy an annuity, you can’t change the terms of the contract. This means you can’t switch to a different type of annuity or get your money back.
Your annuity contract may have a cooling-off period. This means that you can cancel the contract without a penalty within a specific amount of time. Read your contract carefully to see if it includes a cooling-off period.
The contract may give you the option to cancel within a certain period after you start receiving payments. There is usually a fee to do this which can be a percentage of the purchase price.
Contact your annuity provider for more information about your rights to change or cancel an annuity.
If you are thinking about buying an annuity, speak with a financial professional. They can help you figure out what’s right for you, when to buy it and when to start getting payments.
Related links
- Planning and saving for retirement
- Main sources of retirement income
- Choosing a financial advisor
- Canadian Retirement Income Calculator
