Are Back-to-Back Annuities a Good Idea?

Posted on January 26, 2015 and updated January 26, 2015 in Life Insurance Canada News 5 min read
back to back annuities

Annuities are a great way to ensure income in your retired years. Back-to-back annuities, or insured annuities, are particularly useful, but there are a few things you should know and consider first.

What Exactly Is A Back-to-Back Annuity?

It is an annuity you buy that gives you a fixed, guaranteed income for life, backed by an insurance policy that allows you, at the end of life, to pass on the capital to beneficiaries. Additionally, what you receive from annuity payments is enough to cover your life insurance premium and still give you cash in hand. Many have discovered that back-to-back annuities actually help to decrease their annual taxable income because a portion of each payment is considered a return of capital, thereby saving them from OAS clawbacks.
A large investment is best

If you can afford to invest $100,000 or more into a back-to-back annuity, you will stand to benefit the most. This type of annuity is as much about income security as it is about securing your wealth for future generations.

Simplicity

Annuities are very simple and function more or less like a retirement fund. You don’t need a degree in finance or economics to understand how these work, or how to set one up, which is always a bonus! They also provide guarantees, which are also nice when you are investing large sums of money.

Tax Advantages

There is a substantially greater tax advantage to this type of annuity, when compared to GIC’s and other annuities. When you first begin drawing on a typical annuity, the taxable portion of your payout is at its highest point. In contrast, back-to-back annuities utilize a constant taxable portion over the life of the annuity, which aids in manageability and means more pocket money after tax. The life insurance policy also guarantees a tax-free return of the annuity’s purchase price to a beneficiary.

Your Future

No one knows what their future will hold when the retirement years roll around. How will your health be? What will your mental state be like at that point? Will you still be able to take care of yourself? These are the great unknowns, and for many who plan to enjoy retirement, they don’t want to be worrying about making investments and closely monitoring their portfolios. There is a comfort to back-to-back annuities.

Lacking In Options?

When you are over 70 years of age, securing something like life insurance can be challenging. This is another reason why a back-to-back annuity is a great option. It will provide a consistent income that won’t stop once you pass away.
Interest rates matter

These types of annuities work best when interest rates are low, and they are largely recommended for those 70 years of age and older. Keep in mind that this annuity is primarily about leaving a financial legacy and while it is a great idea and option – it may not be for everyone.

What’s All The Worrying About?

Many don’t consider this, but as the average lifespan increases what we need for retirement also increases. If you built your retirement plan on the premise that you were only going to live until the age of 70, then you might find yourself destitute by the time 85 rolls around. Many people have not planned well enough or considered just how long they will be around and by the time they realize it, panic sets in. For those who do hold considerable assets, they have to worry about future market conditions and preserving their financial legacy for future generations.

The Best Case Scenario

The person who stands to gain the most from a back-to-back annuity is a healthy male, age 65 to 75 who gets in when interest rates are low. This is the best possible circumstance for a single-life policy. There are, however, other types of back-to-back annuities that you should consider. There are spousal policies in which you can choose a first-to-die, or last-to-die policy, which will help you control how payments work and when they begin.

A Test Case

Here is a hypothetical example from the Financial Post, of how a back-to-back annuity could work:

“Consider a 70 year-old female with a marginal tax rate of 43.70% who purchases a $500,000 insured annuity at current rates. Her insured annuity pays out $39,222 per year at prescribed terms. She pays insurance premiums but, because her annuity payment includes return of capital, only part of it is taxable. With these deductions the annual net cash flow would be $17,985 per year or 3.60% after-tax and expense yield.” – Quote from Kim Inglis of The Financial Post

So, are back-to-back annuities a good idea? Yes, they are, but there are many factors you need to consider before diving in. First and foremost, you need to consult a financial advisor to explore all the products available to you. If you decide that a back-to-back annuity is the way to go, it needs to be purchased through someone who is licensed to sell insurance. Whether you are single or married, you can benefit from annuities, especially for partners where one is healthy and one is ill (the healthy one carries the policy). Talk to your advisors today.

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