Investors who are turning 69 that are looking to generate retirement income have a few options with respect to their maturing Registered Retirement Savings Plan (RRSP). One is to purchase an annuity that will provide you with a steady stream of income. Individuals intrigued by this option should obtain an understanding of the features and the types of annuities available.
An annuity allows you to invest a lump sum with an insurance company in return for a predetermined income stream. Income received from an annuity purchased with registered assets is 100% taxable, as is the case with any income drawn from a registered account.
Individuals who purchase life annuities will receive an income for the remainder of their lives. This is wonderful if you live to an old age. But what happens to your investment should you die within a short period after paying this lump sum amount for a lifetime of income? To protect against such a loss, you can add a minimum guarantee to the payment period (normally 5, 10, 15, or 20 years). If you, the annuitant, dies, your spouse may elect to have the payments continued. Otherwise, a lump sum, determined by a present value calculation, would be paid. The maximum guarantee period, however, cannot extend beyond age 90. Of course there is a catch – the greater the guarantee period, the lower your payment will be.
There are three general kinds of annuities that are purchased from registered plans:
Term-Certain to Age 90
- Payable to you or your beneficiaries, until the annuitant reaches age 90.
- Regular payments can be monthly, quarterly, semi-annually, or annually.
- Payment amounts are determined at the time of purchase.
Single Life Annuities
- Provides you a guaranteed income for life regardless of the age to which you live.
- May purchase an annuity with guarantee periods to a maximum of age 90 where the payments are guaranteed for the latter of the guaranteed period or your lifetime (if death occurs during the guaranteed period, the commuted value will be paid to the beneficiary).
- With the exception of annuities purchased with a guaranteed period, upon death of the annuitant, payments will terminate, with zero value going to the beneficiaries.
- Payments are generally level for the remainder of your life or can be indexed at a pre-selected rate.
Joint and Last Survivor Life Annuities
- Payable as long as either you or your spouse is alive.
- Provides guaranteed income for life for you and your spouse.
- Similar to a single life, you can select a guarantee period and payments are guaranteed for the latter of the guaranteed period or life for you and your spouse.
- If both you and your spouse die during the guaranteed period, the commuted value will be paid to your beneficiary.
- You also have the option of continuing full payments to the surviving spouse or selecting a reduced income stream on the first death. However, this option must be selected at the time of application.
Interesting points to consider
- It is possible to go from a RRIF to an annuity but it is not possible to go from an annuity to a RRIF (if individuals are undecided we recommend converting to a RRIF until you can make a definite decision).
- It is possible for you to convert your RRSP to an annuity prior to age 69. An individual may want to do this to take advantage of the pension tax credit available at age 65. The good news is that the federal government increased the pension tax credit to $2,000 per year in 2006 (up from $1,000 in 2005). This means that your taxable income may be reduced by this credit.
- Assets in any registered retirement account, including your registered pension plan (RPP), can generally be used to purchase an annuity. Often individuals that leave a place of employment will have the option to transfer the RPP to a locked in RRSP. In many cases purchasing an annuity with this amount may be a good option, especially if the pension tax credit can be utilized.
- The advantage of an annuity is that payments are guaranteed. This is particularly advantageous in the case of a life annuity where the individual lives beyond the age under which RRIF funds would have been exhausted.
- Annuities generally appeal to conservative investors who like low maintenance and guaranteed investments.
- When purchasing an annuity investors should note that control of assets and participation in future market growth is relinquished, and that annuities are not flexible – once purchased, they generally cannot be undone.
- Investors should assess the investments within their RRSP. Some investments are relatively illiquid or have redemption fees if sold. In order to purchase an annuity there must be cash available in the account. It may not be prudent to liquidate a portfolio if there are significant penalties to sell any positions.
Many individuals at retirement may feel that a set monthly income to cover fixed expenses for life may form the foundation of their retirement income. Other individuals may consider an annuity for some of the following reasons:
- Feel that they are in good health and will live beyond average life expectancy.
- May be concerned about outliving their savings.
- Desire to have a fixed income guaranteed for life.
- Not wanting to make investment decisions.
- May be nervous about current equity markets.
- Desire to lock in investments at current rates.
- Not concerned about leaving an estate to their children or grandchildren.
- Desire to solidify financial planning, as income amounts are known.
Understanding your investment objectives, estate planning goals and tax situation will help make your RRSP maturity decision easier. To help you with this decision, your financial advisor can help you prepare a cash flow analysis to determine what you think your expenses will be and what sources of income you have to meet those expenses. This would include your RRSP, as well as other investment assets and income sources and your annual cash flow needs, making sure to account for inflation and emergency situations.
All insurance products are sold through ScotiaMcLeod Financial Services* companies. ScotiaMcLeod Financial Services companies are the insurance subsidiaries of Scotia Capital Inc., a member of the Scotiabank Group. When discussing life insurance products, ScotiaMcLeod advisors are acting as Life Underwriters (Financial Security Advisors in Quebec) representing ScotiaMcLeod Financial Services.
*ScotiaMcLeod Financial Services includes: ScotiaMcLeod Financial Services (Quebec) Inc. and ScotiaMcLeod Financial Services Inc.