Financial Planning - Annuities and Why

 By: Galen Weston
An annuity is a contract issued by an insurance company that returns payments of capital and interest to the holder on a regular basis. The payouts can be fixed or increasing amounts for a set period of time or for the annuitant's lifetime. Annuities have no rescission rights; once you purchase an annuity you cannot amend or terminate the contract.

Term Certain Annuities

These annuities run for a specified period of time, for example 5, 10 or 20 years, or until a certain age of the annuitant has been reached.

Life Annuities

Life annuities, as the name suggests, exist for the lifetime of the holder. The annuity payment varies with the age of the annuitant, and type of life annuity. The older one is when the annuity is taken out, the larger the income over the shortened life expectancy. A life annuity may be a joint and last survivor annuity, where the income goes to one annuitant until death and then the survivor until death. Since two people combined have longer life expectancy than one, the amount of annual annuity income is lower.

A life annuity may have a minimum guaranteed period. If the annuitant dies beforehand, the payments would continue up to the completion of the period. If death occurs after the guaranteed period has expired, the insurance company pays nothing more.

Annuitants living beyond the average life expectancy receive more than those who do not, thus annuities are described as protection for the risk of living too long. Those with life-threatening health problems, significantly shortening life expectancy, may be eligible for annuities with more generous payments.

Registered Annuities

You can purchase an annuity with funds that come from registered retirement savings plans, registered pension plans and deferred profit sharing plans. Pension regulations will require the use of "unisex" mortality rates and usually a joint and survivor annuity with a 60% guarantee to the survivor. The Income Tax Act includes the full amount of each payment from a registered annuity in the annuitant's taxable income, and may allow tax credits.

Non-Prescribed Annuities

With a non-prescribed annuity, only the interest income and not the portion attributable to return of capital, is taxable. The interest portion will be larger in the initial years and smaller over time.

Prescribed Annuities

A prescribed annuity contract (PAC) receives special tax treatment under the Income Tax Act. {(See 12.2ITA reference 12.2 ).} The taxable amount is lower than a non-prescribed annuity in the early years and higher in later years. There is no tax on the return of capital, but the interest that is included in the annuitant's income is level throughout the term of the annuity. Given the time-value of money, this tax treatment is more favourable to the annuitant than is the taxation of a non-prescribed annuity.

Only individuals, not corporations or partnerships, may own a PAC. The policy owner must be the annuitant, a spouse trust or testamentary trust. Annuity payments must be for equal amounts. If the PAC is a joint and last survivor contract, the annuitants must be spouses or siblings of each other. Age plus any guarantee period cannot exceed 91. The annuitant cannot surrender or commute the annuity, except on death.

Deferred and Immediate Annuities

With a deferred annuity, contributions accumulate over a specified period, the interest upon which is taxable during the accumulation. The annuity payments start at maturity. Immediate annuity contracts have no accumulation period. The purchaser pays a lump sum and receives annuity payments immediately.
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Are you thinking yourself... "How should I get the best deal on annuity rates?" If the answer is yes then you might be attracted to the following guidance on annuities. Taking just a short while to understand how the pension annuity system works could be worth thousands of pounds in the future. Straight from the off you should know that it is key that you shop between providers for the best annuity rates. Not completing this process will mean that you cannot be sure of the best rates. This could mean you miss out on a higher retirement income.
An annuity is simply a contract whereby for a fee you can be guaranteed an income for the entirety of your retired life. The regular income from an annuity can offer you security for when you retire. Annuities must not be taken lightly though and it is always recommended that you take the advice of a professional before decide to take up any annuities.
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