If you want to get a guaranteed income for life at a rate of return that is significantly higher than GICs, and still leave an inheritance behind when you pass away, then the insured annuity is a strategy you should consider.
First let me explain how an annuity works: When you establish an annuity, you are purchasing a lifetime income. Examples of annuities are the Canada Pension Plan, Old Age Security, or your retirement pension from your former place of employment. You transfer a specified amount of money to an insurance company and in exchange they will pay you a specific amount of money (typically either monthly, quarterly, semi-annually, or annually) every year for the rest of your life. Because the bulk of the payment is principal, your taxable income will be reduced. However, payments may stop at death and no capital will pass to your heirs.
In the insured annuity strategy, life insurance is used to replace this capital upon death. Even with the added expense of the life insurance premium, this strategy can significantly increase your after-tax income and guarantee it for life while at the same time, preserve capital for your heirs.
How it works: An example
Step one is to buy life insurance. For example, a 65-year-old healthy male non-smoker would be able to purchase $250,000 of life insurance for about $633 a month. The insurance premium is payable for life and ensures that you will leave $250,000 tax-free to the beneficiaries you name.
Step two is to purchase an annuity for $250,000 using non-registered funds. This would yield an income of $1,435.63 a month to our 65-year old male (about 6.9% annually for life). This payment represents both a principal portion of your capital which is totally tax free and a prescribed interest portion which will remain the same each and every year and will be the amount you will include in your income. Annuities can help greatly in reducing tax and increasing retirement income.
The difference between the premium for the life insurance and the income received from the annuity is $803 per month on your $250,000 annuity. Your net return on the $250,000 is therefore 3.85% annually for life. Because of the favourable tax treatment, however, your 3.85% may be the equivalent of having a GIC at over 6% depending on your marginal tax rate. And you leave your original $250,000 behind tax and probate-free.
For those who are not concerned with capital preservation to their heirs, you can simply purchase the annuity, which will greatly increase your annual after tax income for life.
Advantages of Insured Annuities over Traditional Interest-Bearing Investments:
• Increased After-Tax Income – The insured annuity will give a significant increase in after-tax income compared to traditional interest bearing investments such as GICs or Government of Canada Bonds.
• Lower Taxable Income – Taxable income is lowered significantly as most of the annuity income is a tax-free return of principal. The annuity is established on a prescribed taxation basis which spreads out the income portion of the annuity over the lifetime of the annuitant. The T4A that the annuitant receives each year will be the same for their lifetime.
• Possible Reduction in Old Age Security (OAS) Clawback - As mentioned above, the majority of the payment received from a non-registered Prescribed Annuity is a tax free return of principal. This will lower your annual taxable income each year and if you are experiencing clawback on your OAS payments, this can reduce (or possibly eliminate) this clawback.
• No more re-investment risk – With an insured annuity, you don’t have to worry anymore about how long to lock your money in with a GIC or a bond. Or better yet, no more rolling over those 1-year GICs each year waiting for the interest rate to go up.
• Fully guaranteed income – Annuity income is guaranteed 100% up to $2,000 per month of income. This is insured by Assuris which is the equivalent to the bank’s CDIC coverage. You can find out more about this at the Assuris website.
• Lifetime guarantee – no matter how long the annuitant(s) live, the income will pay them for their lifetime regardless of how long that is. If desired, the annuity can be structured to have a minimum guarantee payment period in order to recoup some or all of the principal regardless of when the annuitant(s) die.
• Creditor proof – financial products with insurance companies are protected from creditors in the event of insolvency or a law suit when you have a designated beneficiary named on the policy. As long as you were solvent at the time of establishing the plan, the funds are protected from creditors.
• No probate, legal or other administration costs – At death, as long as there is a named beneficiary on the plan, these funds will pass directly to the named beneficiary without forming any part of the estate. This will then bypass all probate, legal, trustee, and any other administration costs associated with winding up an estate.
• Prompt Payment to Named Beneficiary(s) – When there is a named beneficiary on an insurance policy, payments are paid directly to them without having to wait for the estate to be settled. This gives the beneficiary(s) the funds immediately so that they can use them as they see fit. These funds will be paid usually within 10 business days of the proper claim forms being submitted. With traditional bank-held GICs, beneficiary(s) of an estate normally have to wait for the will to be probated and the estate to be settled before receiving the funds. This can normally take a minimum of 6 months.
• Pension Tax Credit – If you’re over 65 and you don’t have any other qualifying income vehicles, annuities qualify for the pension tax credit which means that you’re first $2,000 of income is tax free.
• Guaranteed Level Life Insurance Premiums – The premiums for Term-100 life insurance are fully guaranteed and will remain level for life, hence the name Term-100. If the insured person lives to age 100, normally premiums will stop but the coverage will continue for the life of the insured.