Why annuities should be on the menu for 2016
Federal tax changes to prescribed annuities are coming in 2017, providing incentive for Canadians to buy while more advantageous rules are still in effect.
By: PAUL BRENT
Date: May 16, 2016
Perhaps the greatest retirement risk is outliving one’s savings – running out of money in what are supposed to be your golden years.
Annuities represent perhaps the best defence against so-called longevity risk, yet they are rarely discussed even among financial advisors. However, 2016 may turn out to be the year of the annuity, when the guaranteed income product comes to the fore as a rock-solid retirement product option.
The reason annuities may be in demand is that federal tax changes to prescribed annuities are coming at the start of 2017, providing incentive for Canadians to buy annuities this year when more advantageous tax rules are still in effect.
“The upcoming changes to prescribed annuity taxation provide significant incentives for clients in or near retirement to purchase their annuity in 2016 if they are using non-registered funds,” says Kari Holdsworth, vice-president of individual wealth at Sun Life Financial. “These changes will increase the taxable portion of each payment and reduce the after-tax income clients receive, so it’s important to review clients’ plans before the new year.”
The major change will be the use of updated mortality tables as of 2017. People who purchase prescribed annuities prior to 2017 will be taxed on a formula that relies on mortality tables that were created in 1971.
The change by Ottawa won’t affect the amount of pre-tax annuity income that people receive, but it will mean higher taxable portions for single and joint life annuities purchased on or after January 1, 2017.
Annuities sold any time prior to 2017 will still use the old mortality tables, even if annuity payments won’t begin until after January 1. The key requirement is that the annuity rates for a client’s annuity need to be “fixed and determined” before the start of 2017. In general, a client’s annuity income has to be set by that date, even if it won’t start until later.
“This rule provides a compelling reason for clients in or near retirement to buy a non-registered payout annuity before January 1, in order to pay less tax,” explains Ms. Holdsworth.
The change to the tax treatment for prescribed annuities was made to reflect the fact that Canadians are living longer and the old mortality tables are out of date, says Jeff Waugh, director of tax, wealth and insurance planning at Sun Life Financial. “People simply were not living as long in 1971 as they are today,” he says. The new mortality tables were drawn up in 2000.
The old, pre-2017 tax treatment for prescribed annuities assumes a shorter lifespan, a lower number of taxable payments and prescribes less tax than what will occur under the new rules.
Mr. Waugh notes that even with the new rules in place in 2017, it does not mean that Canadians should not consider prescribed annuities as a valuable component of their retirement planning.
“Annuities still offer benefits after 2017 and the exact impact of the changes really depends on the tax bracket that the individual happens to be in,” he explains.
The effect of the new mortality tables will not diminish the main benefits of prescribed annuities which are:
- Longevity protection, in the form of lifetime guaranteed income unaffected by market volatility.
- Guaranteed income, which is also the highest level of non-registered guaranteed lifetime income available.
- Tax advantages, as income from a life annuity purchased with non-registered money may qualify for preferential tax treatment, called prescribed taxation.
“The big reason to use annuities is to have the assurance against outliving your money,” says Norma Nielson, the chair of insurance and risk management with the University of Calgary.
Ms. Nielson, who has written a paper on annuities published by the C.D. Howe Institute, argues that prescribed annuities should be modified to allow for cost-of-living features, similar to how Canada Pension Plan (CPP) payments are indexed for inflation.
While she is a big proponent of annuities in general, she expects them to remain under-utilized by Canadians for the foreseeable future.
“It is an artifact of human behaviour for the most part,” she explains. “People have to fork over a lot of money to buy a monthly income, and they don’t like giving up a lot of money.”
Even so, Ms. Nielson contends that more Canadians should be opting to receive at least part of their income in the form of an annuity payment guaranteed for life.
“I think a nice, upper-middle-class person should probably annuitize so that they can have an income that they can live on.”
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