Annuities can be a great option for Canadian retirees looking to supplement their income and protect themselves from financial risks. But before making a decision, it’s important to understand the pros and cons of annuities. In this blog post, we’ll break down everything you need to know about annuities so that you can make an informed decision about whether or not they’re right for you.
What are annuities and how do they work?
An annuity is a type of investment vehicle, typically used in retirement planning, which allows an individual to receive a steady income stream over a period of years, often for life. Buying an annuity is like buying a pension. You put up the money, either registered money like RRSP or open money. Then you receive an income for life. It works by transferring money from either a lump sum or series of payments and converting it into an income stream. For example, you retire. Your pension pays you a lump sum. You buy an annuity with that. You get paid for life.
We have also issued annuities for parents who want to provide their kid[s] with money for life. Perhaps the parents are concerned that the kid will just spend all the money up front. But once the annuity is set up, there is no access to the capital. Just as you cannot call the Ministry of Finance and ask for 20 years future income from your CPP, you cannot ‘cash out’ an annuity.
Annuities are issued by most Canadian insurers. Copycat annuities are only issued by 3 insurers. Banks cannot issue annuities because the amount of future payments is unknown. You may live 5 years or your may live 50 years.
Annuities can be structured in different ways to provide either immediate or deferred income, with the latter allowing for the benefit of compounding over time. Annuities can be issued with or without guarantees. For example, you may want a 15 year guarantee. That way, if you die in year 2 or 3, your heirs or beneficiaries will reap some money. There will be a small cost for any guarantee.
The specific terms and nature of the payout depend on the annuitant’s personal preferences, as well as whether their payment comes in one lump sum or an ongoing income. The latter option provides several benefits including long-term security through market ups and downs but there is no liquidity, i.e. no access to the capital. You are guaranteed the income. The insurer takes the risk of market fluctuations.
In short, an annuity is a powerful tool for those looking to ensure financial stability throughout retirement.
When is the best time to buy an annuity? Any time. Yes, you get a higher payout when interest rates are high BUT during those times inflation is high also so your buying power get eroded.
A defined benefit pension can sometimes be converted to a copycat pension. Consult your pension document or your HR people. If your pension allows the commuted value, you can likely take the copycat pension.
Why would you move a defined benefit pension? Maybe you don’t like your employer. Maybe you don’t trust your employer or the pension plan. Will that pension plan be 100% funded throughout your lifetime? Remember longevity. You’ll likely live to age 85.
What is a copycat pension? It is the SAME as your pension. If your company plan promises to pay your $40k to age 65 then $25k per year til death, that is exactly what the copycat will pay. CRA mandate that a copycat cannot be materially different from your plan. Plus, your plan will have “spousal continuation”. i.e. you die, your spouse or partner gets paid a lesser amount til their death.
Plus, there is often a cash surplus when setting up a copycat. Why? Sometimes the insurer actuary will determine that less cash is needed to offer the copycat. You get the surplus from your pension plan. It’s taxable so look for room in your RRSP.
Pros of choosing a copycat or mirror annuity vs. getting paid through a company pension plan
A copycat or mirror annuity is a retirement income solution in which you transfer a DB pension into an account that mirrors the benefits and income payments of your current workplace pension plan. Your pension is now paid from a Canadian insurance company. Why do that? Canadian insurer are stable domestic financial institutions. Would you rather draw your pension from a small company? A manufacturer? A foreign company? OR a Canadian financial institution? Your choice.
Assuris: this is insurance coverage on insurance companies. IF a Canadian insurer were unable to pay your pension, Assuris will pay that up to $2,000 per month OR 85% of a more lucrative pension. No Canadian insurer has failed since 1989!
Annuities provide a guaranteed source of income for life once purchased, ensuring that you have secure and stable retirement income even if you live longer than expected. Plus, your spouse / partner will continue to be paid after your death, normally 2/3.
Who is an annuity best for?
An annuity may be the perfect retirement tool for those who are risk averse and want guaranteed income in retirement.
Annuities provide the opportunity to save money now in exchange for regular payments (annuity) later, often throughout the entirety of your retirement—a great way to steady and secure your financial future.
If you want to avoid taking risks with your money while still securing extra income, an annuity might be right for you. It is important to note that annuity rates vary, so make sure that you do your research and decide on an option that fits both your needs and budget.