MODULE 13: UNIT 3 Annuities Flashcards
Introduction
An annuity is the simplest retirement income option -> in exchange for a sum of money, a financial institution will provide a series of regular payments for a period of time, like a mortgage payment in reverse
In simple terms, there are two types of annuities:
- “Life Annuities” that guarantee a series of payments for an individual’s lifetime (sometimes referred to as the measuring life)
- “Term Certain Annuities” that guarantee a series of payments for a defined period of time
Registered Annuities
A registered annuity is purchased with assets from a plan that contains registered money, including a:
- RRSP
- LIRA or Locked-in RRSP
- DPSP
- Registered pension plan
- RRIF, LIF, LRIF, or PRRIF
- Refund of premiums
- Designated benefit
- All registered annuities must be immediate annuities and must be designed to provide for a full year of payments in the year following purchase
- Tax deferred savings, funds have not been subject to income tax
- If certain term annuity, must be to age 90
- Calculation is 90 - the annuitants current age
-must be immediate annuities, must be designed to provide for a full year of payments in the year following the purchase.
Non-Registered Annuities
“Non-Registered Annuity” -> An annuity that is purchased with assets that are not from a registered plan
The funds used to purchase the annuity are regular savings and are considered to be after-tax dollars because tax has already been paid on the savings
The distinction between a registered and non-registered annuity is very important because the taxation differs
With a non-registered annuity, the plan owner and the annuitant do not always have to be the same person
- Funds used to purchase the annuity are regular savings and are considered to be after-tax dollars, because tax already been paid on the savings.
- Assets used to purchase non-registered annuities are referred to as tax-paid capital or non-tax-deferred savings
Tax Implications
Registered Annuities
- Payments from a registered annuity are fully taxable to the recipient in the year that the payment is received
Non-Registered Annuities
- There is no tax sheltering associated with the accumulation of the funds used to purchase the annuity (front-end taxation)
Non-Prescribed Taxation
- With a non-prescribed annuity, the interest portion of the annuity is much higher in the early years of the annuity, and because tax is based on the interest component only, normal taxation is subsequently higher in the early years of the annuity
Income Tax Implications: Prescribed Taxation
- To address the unattractive front-end tax situation inherent with non-registered annuities, in 1981 the federal government offered a new tax treatment whereby annuitants could opt to have the annuity treated as prescribed
- With a prescribed annuity, less tax is paid in the early years of the contract than what would normally be paid based on the actual interest earnings of the annuity; a prescribed annuity reports a level amount of interest over the entire length of the annuity, resulting in:
- Tax deferral
- Lower tax in early years and higher tax in later years than would otherwise occur
- Level after-tax income
- Enhanced after-tax income
Income Tax Implications: Calculating Capital and Interest Elements
Step One: Capital Element
Step Two: Number of Annuity Payments
Step Three: Capital Proportion of Each Payment
Step Four: Capital Element of Each Payment
SEE PAGE 13-40
Income Tax Implications: Other Tax Issues
Non-registered annuity payments received after the age of 65 qualify for the Pension Amount federal tax credit
There are also special circumstances where non-registered annuity payments qualify for the Pension Amount federal tax credit for individuals under age 65
Features of Annuities:
The concept of an annuity is built on a series of payments, and the type of funds used to purchase the annuity determines if the annuity is a registered or non-registered annuity
Immediate versus Deferred Annuity
“Immediate Annuity” -> One where the payments begin any time within one year of purchase
“Deferred Annuity” -> Where the annuity payments are scheduled to begin at some date later than one year in the future
Term of the Annuity
The term of the annuity is the period during which the payments will be made
Term Certain Annuity
- Term certain annuities provide guaranteed income for a specified period of time, chosen at the time of purchase
- Once the last contractual payment is made, the annuity terminates
- Term commuted value refers to the present value of the remaining schedule of payments to derive a lump-sum amount that is paid in lieu of remaining payments.
Life Annuities: Straight Life Annuity
Provides income base on a measuring life, that of the annuitant.
- payments are guaranteed for life
- upon death, the annuity terminates and the financial institution is no longer obligated to any further payments
- no guarantee periods
- no benefits or payments paid to a beneficiary
- an insurance contract
Life Annuities: Joint Life Annuity
- based on two measuring lives
- Income is paid during the joint lifetime ot two individuals and continues to the surviving individual for his lifetime or after the first death
- after first death, income payment may continue as 100% or at a reduced amount
Life Annuities: Life annuities with Guarantee Periods
Single Life
- If the annuitant dies during the guarantee period, payments continue to the beneficiary for the remainder of the guarantee period
Joint Life
- If both individuals die before the guarantee period, payments continue to the beneficiary for the remainder of the guarantee term.
Indexed Annuities
- An indexed annuity provides for an annual increase to the regular payment schedule, as selected by the annuitant at the time of purchase, up to a maximum percentage
- The addition of indexation to an annuity is a very costly feature because the financial institution is providing a guarantee that the annual payment amount will increase steadily over the period of the annuity contract
