Annuities are financial investments that provide a steady and reliable stream of income. Annuities are particularly useful for those who are in retirement and are looking for a stream of income to supplement their Canada Pension Plan and Old Age Security payments. They’re highly desirable, widely available and investor protected.
How Annuities Are Formed
Annuities are often provided by insurance companies or banks. These are referred to as the annuity providers. An investor would sign a contract with the annuity provider where his principal or lump sum amount would be used to fund the contract. The investor would name a beneficiary on the contract that would receive the income payments. This beneficiary is referred to as the “annuitant”.
Annuity Payments
The annuity provider would assign an interest rate to the contract and the payments made to the annuitant would be a combination of investor’s principal plus interest. This is known as the annuity payment. The annuity payment would depend on the prevailing interest rate at the time of the contract and the principal amount invested. The larger the principal invested, the higher the annuity payments. The annuity rates offered by insurance companies would differ which is why it’s important to shop around.
Fixed Payments
The annuity payments may be fixed or variable. A fixed annuity payment would be received for the duration of the annuity, no matter if interest rates rise or fall. The payment would stay fixed throughout the lifetime of the annuity.
Variable Payments
Annuity payments may also be variable meaning that they may be tied to an underlying index or mechanism. For example, a variable annuity may link itself to inflation. As inflation increases each year, the payment would increase as well.
Advantage of Annuities
- Easy to Understand – Annuities and the term of annuities are easy to comprehend. An individual who would need a stream of income would sign a contract with an annuity provider detailing the payment, rate and the duration.
- Steady Stream of Income – Annuities provide a steady stream of income that could supplement your CPP, OAS, GIS payments.
- Choice – Annuities provide flexibility and choice. You can choose from a fixed or variable annuity and choice in payment frequency which can be monthly, quarterly, semi-annually or annually.
- Managed – An annuity can give you a piece of mind knowing that you don’t have to make any investment decisions or monitor the performance of the annuity.
- Creditor Protection – Annuities may be protected against creditors or financial claims when a specific beneficiary is named on the contract rather than the estate.
- Estate Planning Benefits – By naming a beneficiary on an annuity, it bypasses the estate and allows you to save probate fees.
Disadvantages of Annuities
- Lack of Flexibility – Once an annuity contract is signed, changes cannot be made.
- Interest Rate Risk – Annuities may be sensitive to interest rates. As the interest rates rise, the annuity payment may be based on the lower annuity rate.
- Penalties – If an contract holder wishes to surrender the annuity contract, then they may face penalties.
Types of Annuities
The two main types of annuities are either a payout annuity or an accumulation annuity. A payout annuity pays an income while a accumulation annuity, is set up for the accumulation of income for the purpose of growth.
Payout Annuity
Payout annuities pay a stream of income which can be a blend of interest and principal. The payments are based on the deposit to the contract and on a specified rate applied at the time of the contract.
- Immediate Annuity – Payments begin immediately with a short period of time between funding and the first payment.
- Deferred Annuities – Deferred annuities are annuities that payments begin at a set date. Once annuity payments begin, they cannot be stopped before the end of the payment period.
- Term Annuity – The annuity payments are for a specified term or number of years.
- Life Annuity – The annuity payments are for life and cannot be stopped.
- Impaired Annuity – An impaired annuity is issued when then annuitant has a shortened life expectancy due to poor health or a serious life disease. Impaired annuities typically have a higher payment due to the diagnosis. These type of annuities are also referred to as enhanced or age rated annuities.
Example of Term Annuity Michael, age 67 deposits, $300,000 to a 5-year term annuity. He receives approximately $3,000 a month in his annuity payments. If the annuity was a 10 year term, he would receive about 1500 per month. When a term annuity ends so do the payments because the annuitant received the entire principal deposited to the contract.
Accumulation Annuity
As the name suggest, an accumulation annuity is a form of savings with a maturity date. Accumulation annuities are similar to GICs but have the benefits of a life insurance contract. The end goal is investment growth with the funds used to buy a payout annuity or withdrawn.
Each time, money is deposited into an accumulation annuity, interest is earned. The interest may be on a daily, monthly or compound basis. Interest
Funding an Annuity
Funding an annuity refers to how the stream of income will generate via. Funding may be made via lump sum or deposits made over a period of time. Funding will depend on the each person’s goal.
An individual who would like an immediate annuity would likely fund the annuity via a lump sum or a transfer of lump sum such as funds originating from a Locked In Registered Retirement Savings Plan.
If an individual would like their payments to start 5 years from now in a form of a deferred annuity, they may fund the annuity through a series of deposits.
Assuris Coverage Protection
When investing in annuities, you can be comfortable knowing that they’re covered by Assuris. Assuris aims to provide investor with comfort knowing that they’ll be there to offer support if an insurer becomes insolvent and cannot meet their financial obligations.
If for example, an insurer who has issued an annuity can no longer meet its payment commitments, Assuris will provide payment in full up to $2,000 per month.
If the payment on a payout annuity is greater than $2,000 a month, Assuris will cover either $2,000 per month or 85% of the promised benefit whichever is higher.
