Annuities in Canada: turning part of your savings into income for life

What an annuity does

When you rely only on invested savings, two unknowns shape your retirement: how markets will behave and how long you'll live. A life annuity removes both from the part of your savings you use to buy it. The insurer pools many buyers, so those who live a long time are balanced against those who don't.

The cost is flexibility. Once purchased, a life annuity generally can't be cashed in, and if you die early the payments stop unless you chose a minimum payment period or a joint-life option. Many people think of an annuity as a way to build a floor of lifetime income alongside CPP and OAS, and then invest the rest.

The main types and options

Annuities come in several forms, and the options you add change both the payments and what happens after you die.

• Single-life annuity: payments for one person's lifetime.
• Joint-and-survivor annuity: payments continue to a surviving spouse, often at the same or a reduced level.
• Minimum payment period (often called a guarantee period): if you die within a set number of years, payments continue to a beneficiary for the rest of that period.
• Indexed annuity: payments rise each year by a set percentage or with inflation, starting lower than a level annuity.
• Term-certain annuity: payments for a fixed number of years rather than for life.
• Deferred annuities: some can be bought now with payments that start years later. Canada also allows an advanced life deferred annuity inside registered plans; its limits and rules are set by the CRA.

What affects the payments

Insurers price annuities using interest rates, their own life expectancy assumptions and the options chosen. Older buyers generally receive higher payments for the same premium because payments are expected for fewer years. Adding a minimum payment period, a survivor benefit or indexing lowers the starting payment.

Because interest rates change, the same premium can buy noticeably different income from one year to the next. Some insurers also offer higher payments to people with certain health conditions. For these reasons this guide doesn't quote market prices; anyone considering an annuity would compare current quotes for the exact options they want.

How annuity income is taxed

If you buy an annuity with RRSP or RRIF money, every payment is fully taxable, just like a RRIF withdrawal. These payments can qualify for pension income splitting with a spouse from 65.

If you buy an annuity with non-registered money, part of each payment is treated as a return of your own capital and isn't taxed. Some non-registered annuities qualify for prescribed tax treatment, which spreads the taxable portion evenly over time. The rules are specific, so confirming them with the CRA before buying is worthwhile.

Annuity income counts toward net income for the OAS recovery tax and for income-tested benefits such as GIS, in the same way RRIF income does.

A hypothetical example: Helen at 70

Suppose Helen is 70, single and lives in New Brunswick. She has $500,000 in her RRIF and $80,000 in her TFSA, receives CPP of $1,000 a month and full OAS, and wants $43,000 a year after tax. The calculator assumes 5% average returns with 2% inflation and works in today's dollars.

With a single fixed return each year, her savings last to 95 with about $110,480 left after tax. But returns don't arrive evenly. When the calculator runs 500 trials with returns that vary from year to year, her spending lasts to 95 in about 61% of them. Savings run out before 90 in about 14% of trials and before 95 in about 39%.

Helen with a hypothetical annuity

Now suppose Helen uses $250,000 of her RRIF to buy a level life annuity, and that it pays a hypothetical $1,450 a month, or $17,400 a year. This is an illustrative figure, not a quote. Because it isn't indexed, its value in today's dollars falls over time, to about $14,274 at 80 and $11,710 at 90.

In the same 500 trials, her spending now lasts to 95 in about 76% of them. Savings run out before 90 in about 6% of trials and before 95 in about 24%. The annuity also keeps paying after her remaining savings are gone, which softens the shortfall in the trials that do run short.

If she chose a hypothetical indexed annuity that started lower, at $13,200 a year but kept pace with inflation, the share of trials lasting to 95 would be about 68%. Lower starting income, more protection later: that's the usual trade-off.

What the example leaves out

The trials assume Helen lives to 95. If she died at 78 with no minimum payment period, the annuity would stop, and the $250,000 she used to buy it wouldn't pass to her estate, while money left invested would. An annuity's value depends partly on how long you live, which no one knows in advance.

The example also leaves out the insurer's own risk, fees built into the pricing and the chance that interest rates at purchase differ from those behind the hypothetical payment. Some retirees phase purchases over several years, or wait until later in their 70s, partly to reduce the effect of buying at one point in time.

For context on the risks an annuity addresses, see longevity risk: planning to 95 and sequence of returns risk. The retirement plan tool lets you enter annuity income as a pension to test your own version, and Monte Carlo planning explained describes how the trials work.