Retirement Annuities

Generically, what is an annuity? An annuity is a time-related blended interest and principal income stream from a pool of capital. The capital is placed with the annuity-issuing institution (usually a life insurance company) and the institution pays the income to the annuitant at stated intervals such as monthly or quarterly. The amount of income is specified and the length of time for the payments to last is specified, such as for the beneficiary's lifetime, twenty years, whatever. In the early stages the income stream consists mainly of interest with a little principal; however the balance gradually shifts over the lifetime of the annuity so that, in the later years, the payments consist primarily of a return of capital.

Retirement annuities are almost always life annuities, meaning that the income lasts for as long as the annuitants (ie owners) live. In these cases only life insurance companies issue them since there is an indefinite period during which the payments will continue, namely the lifetime of the beneficiary. Many other financial institutions issue term certain annuities, those that are payable for a specified number of years, but this hardly ever applies to annuities issued for retirement funds.

Source of funds. The source of the funds dictates the taxation of annuity payments. If the capital sum comes from a government-registered source, such as a registered retirement savings plan (RRSP) or a registered pension plan (RPP), the payments will be fully taxable when received. This is because there was tax relief granted on the funds that were placed in the registered plan in the first place and on the investment returns generated over the accumulation period. So, generally, retirement annuities are fully taxable as the income payments are received by the annuitant(s).

Most retirement income streams, such as registered retirement income funds (RRIF) or deferred profit sharing plans (DPSP) have the option of being converted to a retirement annuity at any time.

Annuity options. Retirement annuities have a number of payment options. For example, payments could continue until the death of both partners in a marriage or other relationship. Or there could be a reduction of the payment amount on the first death or on the death of the primary annuitant (the one whose money was used to purchase the annuity in the first place). Alternatively, the annuity could have a minimum guarantee which might state that payments would continue for the lifetime of the annuitant(s) but for at least fifteen years even if the annuitant(s) die(s) before that. This ensures that the heirs get at least some of the remaining value should the annuitant(s) not live long enough to draw out most of the funds themselves. It is important to understand that the minimum guaranteed period is just that, a minimum guaranteed period; the payments to not stop at the end of the guaranteed period unless the annuitant(s) have died by then. Otherwise the payments continue for however long the annuitant(s) live.

There could be advantages in converting a registered pension plan income stream to an annuity since, otherwise, typically, the pension would cease on the death of the named pensioners (ie typically both spouses). Using the minimum guaranteed period of a life annuity ensures that at least most of the money put in will come out either to the pensioners (ie annuitants) or to their named beneficiaries.