While purchasing a life annuity with non-registered money has had the benefit of providing a lifetime guaranteed income unaffected by the market and interest rates, tax changes coming into effect next year could be a great incentive to buy now.
An annuity is a contract with a life insurance company. You deposit a lump sum of money at a locked-in interest rate and the company agrees to pay you a guaranteed income for a set period of time or for the rest of your life.
Annuities are most often used to generate a secure retirement income. They can be purchased with money from a Registered Retirement Savings Plan (RRSP), a Registered Retirement Income Fund (RRIF) or a non-registered account. The minimum purchase amount for an annuity with Sun Life Financial is $5,000.
Income from a life annuity purchased with non-registered money may qualify for preferential tax treatment called prescribed taxation provided certain qualifications are met. The upcoming tax changes, however, will increase the taxable portion of each payment and reduce the after-tax income that you receive.
Here’s how prescribed taxation works.
After the life insurance company calculates the income for an eligible annuity purchased with non-registered money, it calculates the taxable portion of each income payment using a formula specified by the Income Tax Act (ITA).
The formula takes into account the premium used to purchase the annuity, the amount of each annuity payment and the number of payments you’re expected to receive depending on your life expectancy, which is determined by using tables specified by the ITA.
The taxable portion remains the same for every payment. Generally, the older you are when you buy the annuity the lower the taxable amount.
For some people there will be no tax payable.
After January 1, 2017, the formula is changing and will use update life expectancy tables. People are living longer these days. The current tables use life expectancy data from 1971 but the new tables reflect the significantly improved expectancies.
Under the new rules the annual taxable portion for a male purchasing a single life annuity at age 65 that provides an annual income of $5,906 will rise to $980 from $412. For a single male at age 70 providing an annual income of $6,808 the annual taxable portion will rise to $926 from $272. At age 80 with an annual income of $8,662 the annual taxable portion will rise to $532 from 0 under the existing rules.
Taxable amounts for females purchasing single life policies also will rise. Taxable amounts on a policy purchased at 65 providing annual income of $5,327 will increase to $902 from $496; to $842 from $279 at age 70 providing an annual income of $6,161; and to $291 from $0 at age 80 providing an annual income of $8,043.
Annuities purchased on or after Jan. 1 2017, will use the new life expectancy table to calculate the taxable portion of each payment but annuities purchased before will still use the old tables, even if payments won’t begin until after Jan. 1, 2017. This grandfathering provision is a good reason to purchase before Jan. 1, 2017.
“With high volatility in the markets and with people living longer, annuities provide a stable, guaranteed income and decrease the risk of you out-living your money, but the new tax changes can be quite material, so if you are considering an annuity now might be a good time,” says Brennan Kennedy, vice president of individual wealth products with Sun Life Financial Canada.
If you are considering investing in an annuity talk to a financial adviser to determine if it is right for you.
Talbot Boggs is a Toronto-based business communications professional who has worked with national news organizations, magazines and corporations in the finance, retail, manufacturing and other industrial sectors.