These investment vehicles are issued by insurance companies only and provide a guaranteed stream of income for varying period depending on the type of annuity. They are the simplest form of retirement income that you can get. The income you receive is a combination of interest and principal and is based on several factors including your age, the period that your payment is guaranteed, the lump sum available to invest in the annuity, and prevailing interest rates at time of purchase.
Once you have purchased an annuity you are locked in and cannot make any changes to the income you are receiving nor can you make a withdrawal in excess of the regular payment you are receiving... basically you have locked the door and thrown away the key. This is viewed as a drawback of annuities.
That being said, as part of a diversified retirement income plan, annuities can play an important role.
There are two main types of annuities that can be purchased. There are:
- Term Certain Annuities
- Life Annuities
Term Certain Annuities
These types of annuities provide a guaranteed number of payments, chosen by the purchaser. Depending on whether the money used to purchase the annuity is registered or non-registered they are treated differently from a tax perspective. Your advisor can explain the details.
For example, a 5 year term certain annuity will pay out 60 monthly payments. If the annuitant (the person on whose life the annuity calculations are based) dies before the end of the guarantee period, then the payments continue to the beneficiary until the end of the guarantee period. If your beneficiary is deceased at that time it is paid to your estate.
These types of annuities provide guaranteed lifetime payments, but usually have a minimum guarantee period (the most common is 10 years). In that example, if you purchase a life annuity with a 10 year guarantee, and you die within 10 years, your beneficiary either receives the commuted value of the future payments in a lump sum, or can elect to continue receiving the annuity payments until 10 years of payments have been made. It works the same way with any other guarantee period.
Joint and Last Survivor Annuities
These types of annuities are similar to life annuities except that the payments are guaranteed for the duration of two peoples lives (usually a husband and wife). They can have the same type of income duration guarantee as a life annuity (for example 10 years). Typically, when these annuities are set up, the owners elect a lower income for the survivor (for example 60% of the amount when they were both alive).
Annuities are a very useful component of a well designed and diversified retirement income plan. They do provide certainty so as not to outlive your income in these days of greatly increased longevity, and have many options that allow them to be designed to suit your needs whatever they are.
Guaranteed Interest Certificates (GIC’s)
When it comes to guaranteed investments these are the gold standard. How they work is very simple; you invest a certain amount of money and are guaranteed a certain interest rate depending on the period of time the money is invested for.
The longer the interest guarantee period the higher the interest rate.
Some annuities are redeemable prior to the maturity date, others are non-redeemable (non-redeemable GIC’s may have a higher interest rate).
The guarantee period varies from very short (30 days) to 10 years of longer.
GIC’s are available from banks, trust companies, and insurance companies, and can be purchased with registered on non-registered money.
GIC’s purchased from insurance companies have most of the same estate planning and creditor protection features of Segregated Funds (click here to see those features).