MODULE 13: UNIT 3 Annuities

Question 1

Introduction

Answer 1

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

Question 2

Registered Annuities

Answer 2

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.

Question 3

Non-Registered Annuities

Answer 3

“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

Question 4

Tax Implications

Answer 4

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

Question 5

Income Tax Implications: Prescribed Taxation

Answer 5

• 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

Question 6

Income Tax Implications: Calculating Capital and Interest Elements

Answer 6

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

Question 7

Income Tax Implications: Other Tax Issues

Answer 7

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

Question 8

Features of Annuities:

Answer 8

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

Question 9

Immediate versus Deferred Annuity

Answer 9

“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

Question 10

Term of the Annuity

Answer 10

The term of the annuity is the period during which the payments will be made

Question 11

Term Certain Annuity

Answer 11

• 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.

Question 12

Life Annuities: Straight Life Annuity

Answer 12

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

Question 13

Life Annuities: Joint Life Annuity

Answer 13

• 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

Question 14

Life Annuities: Life annuities with Guarantee Periods

Answer 14

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.

Question 15

Indexed Annuities

Answer 15

• 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

Question 16

Temporary annuities

Answer 16

These provide payments for a specified period, provided that the client remains alive

Question 17

Impaired Annuities

Answer 17

Impaired Annuity” -> Designed to pay a higher income amount than a regular annuity to an annuitant who has been diagnosed with an illness or disability that may reduce his life expectancy

Question 18

Fixed versus Variable Annuity

Answer 18

“Fixed Annuity” -> The most common type of annuity, this provides a guaranteed amount of payment throughout the term of the annuity
“Variable Annuity” -> Where the investment risk is shifted to the annuitant, similar to a RRIF

Question 19

Features of Annuity: Death

Answer 19

The surviving spouse receives the periodic payments if:

• The annuitant had purchased a life annuity with a guaranteed period that was not exhausted before death, and the surviving spouse elects to continue to receive these payments, rather than accept the commuted value of the RRSP
• The annuitant had purchased a term-certain annuity to age 90 and the term was not exhausted before death, and the surviving spouse elects to continue to receive these payments

Question 20

Selection of an Annuity

Answer 20

While the variety of annuity features available allows for flexibility, there is a cost associated with each feature, as well as risk

For example, with a life annuity, the retiree may die prior to his life expectancy and all payments would cease

It is important to consider the features of an annuity relative to the retiree’s specific situation