Please note I am not a licensed insurance agent. This post is for information purpose only.
Upon retirement, many people decide to convert their savings into an annuity. But what is an annuity?
An Annuity is an Income-Guaranteed Contract
You buy an annuity from an insurance company with your savings and the money is returned to you in the form of set payments as well as any interest earned. The insurance company will invest the amount you gave them.
There are different contracts that can match your needs:
- Life Annuity: as indicated in its name, pays you for life
- Time-Certain Annuity: will pay you for a specific period of time
- Variable Annuity: payment amounts depend on the performance of the investment
Upon your death, payments can also be made to your estate or to your surviving spouse, usually a percentage of 50 to 75%.
Pros of Annuities
An annuity is great if you’re concerned with outliving your savings, or you don’t have much savings in the first place.
If you buy a straight-life annuity, payments are guaranteed until you die. A number of term annuities can make payments until you are 90.
Annuities take away investment concerns
With an annuity, you don’t have to worry about selling stocks, bonds and re-balancing your portfolio. The insurer will do it for you.
You’re single with no dependents
Most annuity contracts will stop payments upon your death and will not necessarily return the excess funds to your estate. If leaving a legacy is not a priority, you can choose a higher payout instead.
Cons of Annuities
You’re in poor health
If you are not expected to live a long retirement due to health issues or a terminal illness, an annuity may not be the best solution for you.
You’re locked-in
This is the biggest drawback of this product. Once you have signed the contract, you can’t go back. You no longer have control over the money you handed over, nor can you choose how to invest the money.
The income is calculated at the time you buy the annuity
If interests rates are higher upon purchasing, you can expect a higher payout. If they are lower, your payment will also be.
Age, gender, life expectancy and the amount of money you have also influence the payout.
As a rule of thumb, you are better off buying an annuity when you are 70 or older.
Annuities are taxable
If you buy your annuity from an RRSP or a RRIF, you will be taxed at your marginal rate.
If you buy from a non-registered account, you only pay tax on the interest portion of the payment. As you age, the income received will gradually shift to the principal, lowering your tax bill overtime.
A good tax advantage is with a prescribed annuity. The insurer will pay an equal amount of both principal and interest, evening out the portion subjected to tax.
Check the insurer’s financial position
As annuities are guaranteed contracts, the insurer needs to be in a solid financial position.
Should the insurer become insolvent, Assuris will provide 85% or $ 2 000 of the monthly payout.
Final Word
Annuities are complex products, but they are definitely worth a look. An annuity can be a great part of your retirement plan, but it should never be your entire plan.
The Money Savvy Blog 