Retirement is a special time of life. But from a financial perspective, it can also be a time of uncertainty: how can you ensure that your savings will provide enough income for as long as needed?  

Some are fortunate enough to have a defined benefit pension plan and don’t need to wonder about this question. For everyone else, though, annuities might offer an interesting answer. 

What is an annuity? 

An annuity is a financial product offered by life insurance companies that provides the holder with regular, pre-determined retirement income guaranteed for the term of the contract – even for the rest of the person’s life in the case of a “life annuity.” 

To purchase an annuity, the buyer pays the insurer a lump sum, known as a “single premium”. In exchange, the insurer undertakes to provide a monthly, quarterly, semi-annual or yearly income. The payments are based on factors such as life expectancy and current interest rates. In this way, the annuity frees the retired person from two principal risks. First, investment risk, since this income is guaranteed regardless of what happens on the stock market. And second, longevity risk, since the income can be guaranteed for life, if desired. The person wouldn’t have to worry about outliving his or her savings.  

Life annuity 

The best-known form of annuity is the life annuity. This form guarantees an income until the end of the annuitant’s life. As mentioned above, the income amount is primarily a function of the premium paid, life expectancy and investment return projections determined by the insurer. It will also vary depending on the options chosen. For example, one guarantee might provide that if the annuitant dies prematurely, the annuity payments would continue for a specified number of years: this is known as an annuity with a guaranteed period. Another guarantee could provide for the annuity to be transferred to the spouse after the annuitant’s death: this is known as a joint and survivor annuity. Note that if there are no death-related guarantees, any unpaid capital remains the property of the insurer. Another possible option is an indexed annuity, where the benefits increase over time based on an annual percentage set at the time of purchase. 

The following table gives an idea of the monthly income that might be generated by a $500,000 premium, adjusted for different options (these amounts are fictitious and only serve to illustrate orders of magnitude). As can be seen, each guarantee comes at a cost that reduces the monthly income. This complicates the choice, so the insights provided by an advisor may be invaluable. 

Advanced Life Deferred Annuity 

The advanced life deferred annuity (ALDA) makes it possible to defer the start of your annuity payments for several years – even up to the end of the year in which you turn 85. An ALDA can be purchased with funds from a registered retirement savings plan (RRSP), registered retirement income fund (RRIF), deferred profit-sharing plan (DPSP), pooled registered pension plan (PRPP), or money purchase (defined contribution) registered pension plan (MP RPP). You can use as much as 25% of the funds you have in these plans, up to a defined limit (which is $170,000 for 2024).  

An ALDA offers a number of advantages. First, it can give you peace of mind, knowing that a guaranteed source of income will help you meet your financial needs when you reach an advanced age. This product is also advantageous from a tax perspective. In fact, any funds you put into an ALDA will only be taxed when withdrawn, e.g., when you’re 85, for instance. At the same time, since these funds may have “lightened” your RRIF by a certain amount, the annual RRIF withdrawals required once you turn 71, which are taxable, would be proportionately lower. 

The ins and outs of an ALDA can be rather complex as well. An advisor’s professional services are indispensable. 

Other types of annuities 

Annuities can also take various other forms. For example, an insured annuity  (or “back-to-back annuity”) is an annuity paired with a life insurance policy. It allows the individual to enjoy the advantages of an annuity while still leaving an inheritance for their heirs. Then there’s the annuity certain, also known as a term certain annuity, which is paid for a pre-determined number of years (instead of the annuitant’s lifetime). If the annuitant dies before the end of the guaranteed period, the remaining payments would be made to their beneficiaries. 

It's also important to understand that annuities may differ in how the funds are invested by the insurer. Some, for example, include a responsible investing policy. If that criteria is important to you, be sure to ask about such products. As well, the tax treatment of an annuity may differ based on a range of criteria. If the annuity is purchased with registered funds (money from an RRSP, for example), the income will be fully taxable. If it was purchased with funds from non-registered accounts, the tax treatment may be more advantageous. 

In closing, it goes without saying that your needs and your personal situation must be carefully considered before you decide to purchase an annuity. For example, with the help of your advisor, you could set up a strategy combining the advantages of an annuity with those offered by other sources of retirement income. 

Don’t hesitate to talk to your advisor about it!