Why Your Banker Never Talks About Annuities
Posted by Gail | Filed under Guest Post
Insurance products are a world onto themselves. And for most people, they are very mysterious, which is why you usually need a specialist to understand just what’s what. This guest post comes from Brian Poncelet, an independent certified financial planner who has been working with clients since 1994. Check out his website at www.rightinsurance.ca.
I’ll be back tomorrow with my Financial Literacy Rant!
Every year the financial industry adds new, ever more complicated financial products. But one of the most popular, the annuity, is an oldie but goodie that dates back to Roman times.
Stripped of all the investment world’s jargon, an annuity is a guaranteed and steady stream of income payments that is established at the time of purchase. A person gives money to a life insurance company and over a set period of time will receive a return of this money plus the income earned.
Have you seen the Cash for Life lotteries? Lucky winners get $1,000 per week for life. Lottery organizers love them because instead of handing over a pile of money to the winner, they can buy an annuity from an insurance company and that annuity funds the monthly payments to the winner. See, annuities are everywhere.
Most annuities are bought by those nearing or just entering retirement. Popular among the 60s set, they have a distinct tax advantage. Since those regular annuity payments are made up of both principal and interest and only the interest is taxable, the income doesn’t get gobbled up by taxes. Better yet, the interest can be spread out over the life of the annuity to further minimize taxes.
Perhaps the biggest advantage of the time-tested annuity is that it can be custom-fitted for your particular situation.
Term. If you want your money to last for a particular amount of time, buy a term annuity. Should you die before the term ends, your beneficiary will receive the annuity income payments.
Life Annuities. If you want to make sure there’s money right up until you die, a life annuity is best. You can buy a “single” life annuity for yourself or a “joint” life annuity if you want to make sure your partner also has some money. Life annuities can be bought with or without a guarantee (insured) period. If there is a guaranteed period, the annuity will continue to be paid out for the duration of the guarantee even you (the annuitant) die 5 years before (for example). If there is no guaranteed period, then the 5 years of remaining payments are forfeited to the insurance company.
Indexed Annuity. This type of annuity guarantees a fixed percentage increase in the annuity payment to offset inflation. Typical rates are 4% increase per year.
Insured Annuity (Back-to-Back Annuity). This is a strategy used to back up a life annuity that does not have a guaranteed period. As illustrated above, if an annuitant dies earlier than expected, the balance of the life annuity remains with the insurance company. However if there is a like amount of life insurance coverage in place and the annuitant dies early, the insurance funds will replace the amounts that are left behind by the non-guaranteed annuity. And the heirs of the estate are happier.
Annuities are among the safest investments around because they are financially backed by Canada’s insurance companies, which, like the banks, are the envy of the world for their stability and asset quality. Insurance companies are backed by a nonprofit organization called Assuris (www.assuris.ca). In the event of an insurance company failure, the first $2,000 per month is insured at 100%. Amounts above this $24,000 a year are insured at 85%. Assuris is funded by the life insurance industry and endorsed by the Canadian government.
Why buy an annuity? Well, one reason is that they have a better after-tax return than do GICs. Let’s take a 65-year-old man living in Ontario in the 31.41% tax bracket (income of $40,970 to $65,345). He has $100,000 to invest in either an insured annuity or a GIC paying a rate of 3.25%.
Insured annuity GIC
Gross income $8,165.28 $3,250
Taxes payable $742.90 $1,012.37
Life insurance $3,240 $0
Net Income $4,182.38 $2,237.63
To get the same net income of the insured annuity, the GIC would have to pay interest of more than 6%, about double what you can actually get these days. And if you’re in the highest tax bracket, it would have to pay more than 8%. The other advantages an annuity may provide include avoiding OAS claw backs and age amount (age 65) claw back. Even though current interest rates are low, and people think that’s a reason to hold off on buying an annuity, it’s safe to say that if you’re a very conservative investor, annuities will always give you back more income than GICs because of the way they are taxed.
If you say to yourself, “Why haven’t I heard more about annuities before?” it may be because banks would rather you leave your money with them. As for advisors, only those licensed can sell annuities. Pick the wrong advisor, you’ll never hear a word about annuities. But now that you’ve had the introduction, get to know annuities a little better and you may find you’ve made a new friend.
Brian Poncelet is an independent certified financial planner (CFP) who serves clients in Oakville, Burlington, Mississauga, Toronto and surrounding areas. Many of Brian’s clients are couples who are working toward retirement or have already retired. A large number are self-employed. He specializes in finding money that is being transferred unknowingly or unnecessarily.