Oct 04, 2021

Could your years be more "golden" with an insured annuity?

Retirement is often referred to as “the golden years.” Life is thought to be calm and idyllic. This, of course, assumes a sense of confidence around one’s finances. Unfortunately, that’s not always the case.

A recent survey by RBC Insurance polled 1000 Canadians aged 55 to 75, and found that 60% of them are concerned they’ll outlive their retirement savings. Further, 45% don’t feel confident they’ll be able to afford the kind of retirement lifestyle they desire.  

The dilemma

Retirement plans tend to rely on investment portfolios which are heavily weighted toward fixed income assets such as GICs. The intent is to provide a stable income while preserving capital. If the capital is preserved and only the interest earnings are spent, this enables retirees to leave an inheritance on their passing. The problem with this strategy is that the current and prolonged low interest rate environment provides significantly less income than it used to, which means it requires significantly more assets to produce the same income.

For example, if $50,000 of before-tax retirement income is needed, it can be produced from a capital amount of $1,000,000 if interest rates are at 5%. But if interest rates of just 2% are available, $2,500,000 of capital would be required to generate the same $50,000 before-tax retirement income. Further, interest income is taxed at the top marginal rate, which means that less of the $50,000 will be available for spending than if it had been generated from a more tax-efficient asset class.

An alternative way forward

So, is there a way to get tax-efficient, guaranteed lifetime income that will also leave an inheritance to loved ones? The solution might lie in an insured annuity strategy.  

This strategy is twofold. It involves investing your capital in a life annuity to create lifetime guaranteed income, and purchasing a permanent life insurance policy on the life of the annuitant to replace the capital on death. Even after paying the insurance premiums, the net after-tax spendable income under the insured annuity concept often exceeds what’s available through buying GICs and only spending the interest income. Both strategies leave behind the same estate to heirs, but the insured annuity strategy offers higher and more tax-efficient income. 

Let’s discuss the details of this insured annuity strategy.

What is an annuity?

An annuity is an investment vehicle offered by insurance companies wherein capital is traded for a guaranteed income stream. Once purchased, it’s usually not possible to return the annuity to cash. There are two types of annuities: term and life.

A term certain annuity provides a guaranteed income stream for a defined length of time. For example, a 20-year term certain annuity will provide a guaranteed income stream for 20 years. At the end of the 20 years of income, the capital is gone.  

A life annuity will provide a guaranteed income stream for the life of the annuitant. It will also guarantee the income for a set number of years, so that if the annuitant were to die before the end of the guarantee period, the beneficiary would receive the balance of the guaranteed income stream. If the annuitant dies after the guarantee period is over, the income stream stops and the capital is gone.

Annuity sources and taxation

Annuities from RRSP or RRIF assets are fully taxable income. Annuities from non-registered assets may result in a prescribed annuity. A prescribed annuity has preferential tax treatment in that only a small portion of the income paid out is taxable, while the remainder is considered to be return of one’s own capital and, therefore, is not taxed. The mix of taxable and non-taxable income from a prescribed annuity remains constant for the life of the annuitant.

The insured annuity concept usually involves the use of non-registered funds as the source for the purchase of a life annuity. This provides guaranteed lifetime tax preferential income. It may result in reduced OAS claw back and increased eligibility for other income-tested benefits.

The chart below breaks these figures down at a glance. 

 

$500,000 invested in

GIC @ 3%

Prescribed annuity, insured 

Income generated

 $15,000

 $27,266.76

Taxable income

 $15,000

 $1,756.61

Tax payable1

 $5,460

 $632

Annual life insurance premiums

 -

 $15,075

Spendable income

 $9,600

 $11,559

Amount to heirs

 $500,000

 $500,000

$ improvement vs GIC strategy

 -

 $1,959

% improvement vs GIC strategy

 -

 20%

1Assumes a 36% marginal tax rate
Source: Canada Life life annuity and Manulife T100 life insurance

 

Final considerations 

Some might argue that today’s low interest rate environment would be the wrong time to purchase an annuity and lock in the income stream based on the current rates. However, what’s misunderstood is that the amount of income generated by the annuity, especially in older ages, is driven as much by age as rate.  This is because the older one is, the more compressed the time period over which the annuitant’s capital and earnings are paid out, thus increasing the monthly income.  

There’s a sweet spot age group for this concept. It’s from about age 60 to 75, and perhaps even a bit older for females or for joint and last-to-die situations. This is because the older one is, as described above, the higher the monthly income. The flip side is that age also increases the cost of the insurance.

Given that some of life’s expenses are lump sums coming at uneven and sometimes unplanned intervals, it wouldn’t be prudent to tie up all of your capital into this concept. But you may want to consider placing enough of your capital into this strategy so that your monthly fixed expenses are covered.

Your Wealth Preservation Advisor can analyze your situation to see if this strategy is a fit for you.

This blog is for informational purposes only. It is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon as advice. Please contact your lawyer, accountant or other advisor for relevant advice. CWB Group takes reasonable steps to provide up-to-date, accurate and reliable information but is not responsible for any errors or omissions contained herein. Information obtained from third parties is believed to be reliable, but no representation or warranty, express or implied, is made by CWB Group or any other person as to its accuracy, completeness or correctness. CWB Group reserves the right at any time and without notice to change, amend or cease publication of the information. Click here to view the full disclaimer.