Definition of an Annuity

It is purchased from an insurance company or financial institution in exchange for a lump sum or regular contributions.

Annuities help retirees ensure a steady income stream, reducing financial uncertainty. In Canada, annuities are commonly used within Registered Retirement Savings Plans (RRSPs), Registered Retirement Income Funds (RRIFs), and non-registered investment portfolios.

For example, a Canadian retiree investing $200,000 in an annuity may receive $1,200 monthly for life.

Purpose of an Annuity in Financial Planning

Annuities provide stable and predictable income, making them essential for:

1. Retirement Security – Ensuring consistent payments to cover living expenses.
2. Longevity Risk Management – Preventing retirees from outliving their savings.
3. Market Risk Protection – Offering fixed income unaffected by stock market fluctuations.
4. Tax-Efficient Income – Some annuities provide tax advantages, especially in registered plans.
5. Estate Planning – Certain annuities offer beneficiary options to pass income to heirs.

How an Annuity Works

1. Purchasing an Annuity

An individual buys an annuity with a lump sum or multiple payments.

Example: A retiree deposits $100,000 in a life annuity, receiving guaranteed monthly payments.

2. Accumulation vs. Payout Phase

• Accumulation Phase – The period when funds grow tax-deferred before payments start.
• Payout Phase – When annuity payments begin, based on contract terms.

Example: A deferred annuity accumulates interest for 10 years before converting to regular payments.

3. Receiving Annuity Payments

Payments depend on:

• Annuity type (fixed, variable, indexed, etc.)
• Investment amount
• Interest rates and life expectancy

Example: A registered annuity pays out income while deferring taxes until withdrawal.

Types of Annuities in Canada

1. Life Annuity

Provides guaranteed income for life, preventing retirees from running out of savings.

Example: A $500,000 life annuity pays $2,500 monthly for life.

2. Term-Certain Annuity

Pays fixed payments for a set number of years, regardless of the annuitant’s lifespan.

Example: A 20-year annuity pays the annuitant or their beneficiary for 20 years.

3. Variable Annuity

Payments fluctuate based on investment performance, allowing potential growth.

Example: A market-linked annuity earns returns based on the S&P/TSX Index.

4. Registered vs. Non-Registered Annuities

• Registered annuities (RRSPs, RRIFs) offer tax-deferred growth.
• Non-registered annuities provide tax-efficient withdrawals, where only the interest portion is taxable.

Example: A non-registered annuity may have lower taxable income due to return-of-capital payments.

Annuity vs. Pension vs. RRIF

Category	Annuity	Pension	RRIF
Definition	A financial contract providing scheduled payments	Employer-sponsored retirement income	A flexible retirement income fund
Payment Type	Fixed or variable	Lifetime payments based on work history	Withdrawals based on minimum CRA rules
Market Risk	No risk (fixed annuities)	No risk	Exposed to market risk

For example, an annuity guarantees fixed income, while a RRIF depends on investment performance.

Tax Implications of Annuities in Canada

1. Taxable vs. Tax-Free Annuities

• Registered annuities (RRSP annuities) are fully taxable upon withdrawal.
• Non-registered annuities have tax-efficient payments, as only the interest portion is taxable.

Example: A $2,000 registered annuity payment is fully taxed, while a non-registered annuity payment may have a lower tax liability.

2. Pension Income Tax Credit

Retirees aged 65+ can claim a $2,000 annual tax credit on eligible annuity income.

3. Withholding Tax on Lump Sum Withdrawals

Large annuity withdrawals trigger withholding tax, ranging from 10% to 30%.

Example: A $30,000 RRSP annuity withdrawal is subject to a 30% withholding tax.

Advantages and Disadvantages of Annuities

Advantages

• Guaranteed Lifetime Income – Provides financial security.
• Market Risk Protection – Fixed annuities shield retirees from market volatility.
• Tax Benefits – Registered annuities grow tax-deferred.

Disadvantages

• Limited Liquidity – Funds are locked once annuitized.
• Potential Inflation Risk – Fixed annuities may lose purchasing power.
• Lower Growth Potential – Stock investments often outperform annuities over time.

Related Terms

• Annuitization: The process of converting a lump sum into scheduled payments.
• Deferred Annuities: Annuities that start payments at a future date.
• Guaranteed Income Supplement (GIS): A Canadian government benefit providing low-income retirees with additional income.

Interesting Fact

Did you know that Canadian annuity rates fluctuate based on bond yields, meaning higher interest rates lead to higher annuity payments?

Statistic

According to Statistics Canada, over 40% of Canadian retirees include annuities in their financial plans for guaranteed income stability.

Frequently Asked Questions (FAQ)

1. When should I buy an annuity?

Most Canadians purchase annuities between ages 60 and 70 for retirement income security.

2. Can I withdraw money from an annuity?

No, lump sum withdrawals are not permitted once annuitized.

3. What happens to my annuity if I die?

• Life annuities stop payments upon death.
• Term-certain annuities pass payments to a beneficiary.

4. Are annuities affected by inflation?

Fixed annuities do not adjust for inflation, but indexed annuities offer inflation protection.

5. Are annuities a good investment?

Annuities provide secure lifetime income, but stocks and mutual funds offer higher growth potential.