How to Create a Guaranteed Retirement Fund with Life Annuities

Life Annuities are a contract that’s typically sold by life insurance carriers where the client can deposit a lump sum of cash, and depending on the nature of that deposit, the insurance company can offer them a contract, which guarantees them an income over their lifetime.

According to Alex Lekas, director of sales in Ontario for Industrial Alliance Insurance and Financial Services Inc., there are various marked advantages to this arrangement, including income security, peace of mind, help with retirement planning, and tax efficiencies that may be available in the future.

Of course, along with these advantages come with one major shortcoming. “Once you make that cash deposit, you are essentially locked into the contract, so even though you are getting this guaranteed income for life, you no longer have any flexibility with the money.” says Lekas.

“Essentially, the deposit is to the insurance company, and you never get it back beyond those periodic payments, so should you need a little bit more money for a different situation, you can’t get any. You lose some of the flexibility in terms of what you can do with that lump sum of money.”

Annuities come in two varieties, individual and joint. An individual annuity is a contract for an individual, while a joint annuity is shared between two people, such as a husband and wife.

“When you’re looking at a joint annuity, as opposed to an individual annuity, you may be constrained as to the choices you can have, such as how long the payout is or the amount of income that’s paid out,” says Lekas.

Annuity incomes are determined based on a person’s age, income, and gender, so when you combine two people into a joint annuity, those factors are averaged and taken into account.

“However, in a joint annuity, when the first person dies, that income stream can still continue, so that’s a nice benefit to have. Whereas, typically with an individual annuity, the income is paid for the life of that person. So, when they die, that income generally disappears,” Lekas points out.

Annuities are usually sold using one of two forms of payment, either registered funds, such as money that could come from an RRSP, or what’s called a Long-Term Retirement Account. You can also use non-registered funds from open mutual funds or even money in your chequing account.

For example, if you’re using non-registered money, you can purchase a Life Annuity that pays the person for the rest of their lives, or a Term-Certain Annuity, which pays the person an income for a certain period of time, such as 10 years, 20 years, or longer. Lastly, non-registered money can get you what’s called a Prescribed Annuity, which means the tax treatment of this income is spread out more evenly over the life of the contract, so the client gets to take home more money. Another option is pairing an annuity with life insurance.

“Those are just two separate strategies commonly referred to as back-to-back,” says Lekas.

“In effect, what the client would do is they would invest a dollar amount of money, say $250,000, and they purchase an annuity that would pay them for the rest of their lives. Then, what they’ll do is purchase a life insurance policy that will protect them for the rest of their lives and when they pass away, the benefit of $250,000 will get paid as a life insurance policy. This means that they will have received an income for their $250,000 while they were alive and their beneficiary will receive their $250,000 when they pass away.”

Of course, while the client has that life insurance policy, they will be paying premiums, so they will have to decide whether some of the income they get is worth putting up towards the insurance premiums in order to leave money to their beneficiaries.

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