WEALTH
Annuities
Before you act on anything about tax on this page
This practice is licensed in life and health insurance. It is not an accounting practice, it does not prepare returns, and nothing on this page is tax advice or an opinion on anybody’s tax position.
- Speak to an accountant before you act. Not after. If tax is any part of the reason a decision is being considered, a professional accountant who has seen the actual file is the person to decide it with, and this page is not a substitute for that conversation.
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- The tax authority is the authority. For anything a reader intends to rely on, the Canada Revenue Agency and, in Quebec, Revenu Quebec publish the current rule themselves, free, and that is where it should be read.
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In plain language: we are not accountants. Anything here that touches tax is general information, it changes, and it should be checked with an accountant and against the tax authority’s own page before anybody uses it for anything.
An annuity turns capital into an income the insurer is obliged to pay: for a stated number of years, or for life. The capital is handed over, and the payment becomes a contractual obligation.
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What decides an annuity
- A life annuity and a term certain answer different questionsA life annuity pays for as long as you live, however long that turns out to be. A term certain pays for a stated number of years and then stops.
- The trade is access for certaintyThe capital is given up. In return the amount written in the contract is guaranteed by the insurer and does not move with markets.
- The guarantee belongs to the insurerThe payment is the promise of a Canadian insurer. Assuris, the industry protection body, covers annuity payments within stated limits if an insurer fails.
What an annuity actually is
An annuity is a contract with a life insurance company. The holder hands over a sum of capital and the company promises to pay an income on a schedule. If the contract is a life annuity, those payments continue for as long as the annuitant lives, however long that turns out to be. That promise is the whole of the product.
It is worth saying plainly the part that most descriptions leave out. In the usual form, the capital is given up. It stops being an account with a balance in it. There is nothing left to withdraw, nothing to rebalance, and nothing to leave to anybody except whatever a guarantee period or a second life on the contract preserves. The money has been exchanged for a promise, and the promise is now the asset.
That exchange is why an annuity feels uncomfortable to somebody who has spent thirty years watching a portfolio balance. The balance disappears from the statement. What replaces it is a payment that arrives whether markets fell, whether interest rates moved, and whether the annuitant lived a great deal longer than any reasonable plan assumed.
An annuity is issued by a life insurance company because the risk it absorbs is a mortality risk. Nobody else is in the business of paying an income to a person for an unknown number of years and pricing that promise across a large group of lives. The product exists because that pooling exists, and the pooling is what a household is actually buying.
What is given up, and what comes back
The trade is easy to state and hard to accept. The holder gives up control of the capital, gives up any future growth on it, and in most forms gives up the ability to leave it to somebody. In return the holder gets an income that cannot run out and that requires no further decisions.
What is bought is certainty about a number nobody can know, which is the length of a life. A household drawing from a portfolio has to guess how long the money must last, and every guess is wrong in one of two directions. Guess short and the money runs out while the household is still here. Guess long and the household lives more carefully than it needed to, for years it does not get back.
The annuity removes that guess for the portion of capital used to buy it. It removes it for nothing else.
The cost of removing it is real and should be looked at squarely. Liquidity is gone: once the payments have started the contract usually cannot be undone, and a household that suddenly needs a lump sum for a roof or a car or a crisis cannot get it from here. The estate is affected: with no guarantee period and no survivor, payments stop at death and nothing passes on. And inflation is a live problem unless the contract was arranged to address it, because a level payment buys less in every year of a long retirement.
None of that makes it a poor instrument. It makes it an instrument with a narrow job, which is a different thing, and the rest of this page is about what that job is.
One life, two lives, and what a guarantee period does
The first structural decision is whose life the contract runs on.
A single life annuity is measured on one person. Payments continue while that person lives and stop when that person dies. For a given amount of capital it produces the largest payment of any form, because the promise is expected to end soonest.
A joint and survivor annuity is measured on two lives, usually a couple. Payments continue while either is alive, and the contract states whether the payment to the survivor stays at the same level or steps down. Because the promise is expected to run longer, the payment is smaller than the single life payment bought with the same capital. That is not a fee and it is not a penalty. It is the price of a longer promise.
Choosing between them is a household decision rather than an arithmetic one. A couple whose retirement income would collapse on the first death has a different problem from a couple where each already holds secure income of their own.
A guarantee period sits on top of either form. It says that payments will be made for at least a stated number of years whatever happens to the annuitant. If death occurs inside that window, the remaining payments, or their value, go to the beneficiary or to the estate as the contract provides. If death occurs after it, the guarantee has done nothing and has cost something, because a longer guarantee reduces the payment.
The guarantee period is what people reach for when the fear is dying early and losing the capital, and it is worth being clear about what it buys. It protects the money, not the income. The income was already protected. The guarantee is there for the beneficiaries and for the peace of mind of the person signing.
A life annuity and a term certain annuity are not the same product
A life annuity pays for a life. A term certain annuity pays for a stated number of years and then stops, whether the annuitant is alive or not.
They sit side by side on the same shelf and they answer different problems. The term certain annuity turns capital into a predictable stream across a known window: a bridge to the date a pension starts, or a run of years a household wants covered before another income begins. It carries no longevity protection whatever. When the term ends, the payments end, and a person who is still alive and still needs income has to find it somewhere else.
The life annuity is the one carrying the longevity promise. It is the only version of this product that answers the question a household is usually afraid of, which is what happens if the money has to last a great deal longer than anybody planned for.
A household that buys a term certain annuity believing it has secured lifetime income has bought the wrong contract. The names are close, the payments look alike on a page, and the difference only shows up in the year after the term ends. Ask which one is on the illustration, and ask in plain words what happens the month after the last payment.
There is a third variant worth naming because it appears in every discussion of registered money. An annuity bought inside a registered plan has to be structured in a way the plan rules permit, and a term certain annuity used in that setting is commonly written to a fixed age rather than for a fixed run of years. The point for a reader is only that the shape of the contract is constrained by the source of the money, which is the next section.
Registered money, non registered money, and why the source decides the tax
The single most misunderstood thing about annuities in Canada is that the tax treatment does not come from the annuity. It comes from where the money came from.
If the capital comes out of a registered plan, a registered retirement savings plan or a registered retirement income fund or a pension, the income is taxable in full as it is received. That is the same treatment the money would have had in any other shape. The annuity did not create the tax and does not reduce it. What it does is convert a plan somebody had to manage, with a minimum that has to come out every year, into a payment that is fixed and asks nothing of the holder. Our page on minimum withdrawals describes the arrangement being replaced.
If the capital is non registered, the money has already been taxed once. Only the interest element of each payment is income. The rest is a return of the holder’s own capital and is not taxed again. That distinction is what makes a non registered annuity behave unlike an ordinary investment, and it is the subject of the next section.
This is why two people receiving what looks like the same payment can keep very different amounts of it. Nothing about the two contracts differs. The history of the money differs.
A related point catches households out. Money moved out of a registered plan into a non registered annuity is a taxable event in the year it comes out, whatever is done with it afterwards. The numbers in any specific case belong to a specific contract at a specific time, and the calculation goes to a qualified tax professional.
The prescribed annuity, and why the taxable portion is levelled
Take a non registered annuity. Each payment is part interest and part return of capital. The only question is how the interest element is measured.
Under the ordinary rule it is measured as it actually accrues. Early payments come out of a large remaining balance, so they carry a large interest element and a large tax bill. Later payments come out of a smaller balance and carry less. The taxable income is front loaded: heaviest at the start, lightest at the end. That is the opposite of the shape a retired household wants, because the first years of retirement are often the years other income is highest.
A prescribed annuity is taxed differently. The contract has to meet conditions set out in the Income Tax Act and its regulations, and where it does, the taxable portion of each payment is levelled: the same taxable amount in every payment for the life of the contract, rather than a large one at the start and a small one at the end. The Canada Revenue Agency bulletin IT-87R2 sets out the department’s position on how a policyholder’s income from contracts of this kind is determined.
The practical effect is that a household knows from the first payment exactly what part of it is taxable, and knows that the figure will not drift upward as the years pass. For a retired person managing income tested benefits, a stable and lower taxable amount in the early years is worth more than the arithmetic on its own suggests, because the tax bill is not the only thing that moves when taxable income moves.
The conditions are real conditions and not every contract meets them. Whether a particular arrangement qualifies is a question for the insurer that issues it and for a qualified tax professional, and it is a question to settle before the capital moves rather than after.
Buying now, or waiting
The deferral question is the one every household asks. Should the annuity be bought at retirement, or later?
Two things argue for waiting. The payment produced by a given amount of capital rises with the age at which the contract is bought, because the promise is expected to run for fewer years. And capital left invested may grow in the meantime, which would mean more capital to convert when the time comes.
Two things argue against it. The household carries the longevity risk itself for every year it waits, and that is precisely the risk it was thinking of handing over. And the capital left invested may not grow: a fall in the years immediately before the purchase reduces the amount available to convert, and nobody knows in advance which years those will be.
There is a quieter argument for waiting that has nothing to do with markets. Spending is not level across a retirement. Most households spend more in the first active years, less through the middle, and then meet a different kind of cost late in life if care is needed. An income that starts later matches the shape of that late cost better than one that starts at retirement and is partly spent on years the household could have funded from capital anyway. That late cost is its own subject and is dealt with under long term care insurance.
What should not decide it is a view about where interest rates are going. A household waiting for a better rate is making a market forecast with the one pot of money it cannot afford to be wrong about, and it is answering a different question than the one that sent it looking.
This is longevity insurance, so measure it against the right thing
The commonest mistake made about annuities is measuring them as investments. Set beside the return of a balanced portfolio over a long period, an annuity looks poor, and the comparison is empty because the two things are not doing the same job.
An annuity is insurance. What it insures is the risk of living a long time. Like every other insurance contract, its value is not measured by what the average holder gets back. It is measured by what happens to the holder for whom the insured event occurs. Fire insurance looks like a poor investment to everybody whose house does not burn, and nobody uses that as an argument against owning it.
The insured event here is a long life. Somebody who dies early has, in strict money terms, done badly out of the contract, and that person was never the one the contract was bought for. Somebody who lives far longer than the tables expected has an income no portfolio drawn down at a sustainable rate would have produced, and that person is exactly who it was bought for.
Framing it this way changes the question a household asks. Instead of asking whether an annuity will beat the market, it asks what it would cost to be wrong about how long it lives. If being wrong is survivable, the household may not need this contract at all. If being wrong means depending on somebody, the contract is answering a real exposure and the market comparison was never the point.
It is worth saying what an annuity does not insure. It does not insure against inflation unless the contract was arranged to. It does not insure against the cost of care. And it does not insure a family against the loss of the annuitant, which is a life insurance question and belongs under permanent life insurance.
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Read the guideThe annuity beside the alternatives it is actually competing with
There are four ways a household turns retirement capital into money to live on, and a fifth that people forget is also a choice.
| Approach | What is promised | Who carries the risk | What is left at death |
|---|---|---|---|
| Life annuity | An income for as long as the annuitant lives, fixed when the contract is issued. | The insurer carries the longevity risk and the investment risk. | Nothing, unless a guarantee period or a second life was built in. |
| Term certain annuity | An income for a stated period, and then nothing. | The household, because the payments stop while it may not have. | The remainder of the term, where the contract provides for it. |
| Systematic withdrawal from a portfolio | Nothing. A withdrawal plan is a decision, not a promise. | The household carries the longevity risk, the market risk, and the risk that poor returns arrive in the early years. | Whatever has not been spent. |
| Segregated funds with a guaranteed withdrawal feature | A stated withdrawal level backed by a contract, with the fund still invested. | Shared, on the terms the contract sets, and paid for through the charges the contract makes. | The remaining value, subject to the contract. |
| Leaving the capital alone and spending only the income it throws off | Nothing, and usually a lower standard of living than the household could afford. | The household, mostly in the form of years it lived more carefully than it had to. | The capital, intact. |
The row that reads worst on paper is often the honest one. A systematic withdrawal promises nothing at all, and a great many retired households in Canada are living on exactly that, with the promise supplied by hope and by a spreadsheet. The reason for putting the annuity beside it is not to argue for the annuity. It is to make visible who is carrying the risk in each row, because in three of those five the answer is the household.
Why the answer is almost never all of it
Almost nobody should convert everything into an annuity, and almost nobody should convert nothing. The decision is a proportion, and treating it as a yes or no is what makes it feel enormous.
The method that survives contact with a real household is to separate spending into two kinds. There are the costs that arrive whether or not anybody feels like paying them: property tax, insurance, heat, food, the minimum of a life. And there is everything else: travel, gifts, the discretionary part that can be cut in a bad year without anybody suffering for it.
The fixed costs are the ones that should be met by income that cannot stop. For many households a good part of that is already covered by government benefits and by a pension where one exists. The gap between what those pay and what the fixed costs actually are is the natural size of an annuity, and it is frequently a much smaller share of the capital than people expect before they do the arithmetic.
Everything above that line stays invested, stays liquid, stays available for the roof and the emergency and the estate. The household keeps flexibility exactly where flexibility is useful and gives it up only where certainty is worth more than flexibility.
This is also the answer to the fear about dying early. A household that converted a portion still has the rest, and the rest is what passes on. The all or nothing framing that makes this decision feel irreversible is a framing, not a constraint of the product.
What stands behind the promise
An annuity is a promise from a life insurance company, so the strength of the promise depends on the company. On a contract that may run for decades that is a real consideration and not a theoretical one.
In Canada, protection for annuity contracts is provided by Assuris, within its limits. Assuris is the industry funded organisation that protects Canadian policyholders if their life insurance company fails, and annuity payments are among the benefits it covers, up to the levels it publishes.
What it is not is deposit insurance. An annuity is not a deposit and is not covered by the Canada Deposit Insurance Corporation. A household that assumes the two work the same way, or that assumes coverage is unlimited, has assumed something untrue about the contract it is signing.
The limits are published by Assuris and they change from time to time, which is why they are not printed here. A household placing a large sum should read the current limits on the Assuris site and then decide whether the amount belongs with one company or is better split. That is a structural question, it costs nothing to ask, and it can only be answered before anything is signed.
The five mistakes this page exists to prevent
Comparing an annuity to a portfolio return. It is insurance against a long life, and the only honest comparison is against what happens to the household if the money has to last much longer than planned.
Buying a term certain annuity while believing it pays for life. Ask which one is on the illustration and ask what happens the month after the term ends.
Choosing a single life form on a couple where the survivor would be left without enough income. The larger payment is larger because the promise is shorter, and the survivor is the person who finds that out.
Ignoring inflation. A level payment across a long retirement buys steadily less, and a household that has covered its fixed costs today has not necessarily covered them in twenty years.
Treating it as all or nothing. The useful question is what proportion of the capital should carry a promise, and for most households that proportion is neither everything nor zero.
Questions people ask
If I die soon after buying an annuity, does my family get the money back?
Not unless the contract was built that way. A plain single life annuity ends at death and nothing passes on. A guarantee period keeps payments running for a stated number of years whatever happens, and a joint and survivor form keeps them running while the second person lives. Both reduce the payment, because both lengthen the promise the insurer has made.
Is an annuity a good investment?
It is not an investment, and measuring it as one produces a misleading answer. It is insurance against living a long time. Its value shows up for the holder who lives far longer than expected, in the same way that fire insurance shows its value only to the household whose house burns.
Can I cancel an annuity if I need my money?
Generally no, once the payments have started. That loss of liquidity is the central cost of the contract and it is the reason the decision is usually partial: convert the portion that has to produce income no matter what, and leave the rest invested and reachable.
Why is my neighbour’s annuity taxed differently from mine?
Because the tax follows the source of the money rather than the contract. Capital coming out of a registered plan produces income that is taxable in full. Capital that is non registered has already been taxed once, so only the interest element of each payment is income. Two identical contracts can therefore be taxed very differently.
What is a prescribed annuity?
A non registered annuity that meets conditions set out in the Income Tax Act and its regulations, with the result that the taxable portion of each payment is levelled across the life of the contract instead of being heaviest in the early years. The Canada Revenue Agency bulletin IT-87R2 sets out the department’s position on how that income is determined. Whether a particular contract qualifies is for the insurer that issues it and for a qualified tax professional.
Should I wait for interest rates to be higher before I buy?
Waiting is a market forecast made with the one pot of money a household cannot afford to be wrong about. There are honest reasons to defer, including that the payment for a given amount of capital rises with age and that spending late in retirement has a different shape from spending early in it. A view about rates is not one of them.
What happens to my income if the insurance company fails?
Protection for annuity contracts in Canada is provided by Assuris, within the limits it publishes, and those limits change from time to time. This is not deposit insurance and the Canada Deposit Insurance Corporation does not cover an annuity. A household placing a large sum should read the current limits and decide whether the amount belongs with one company or should be split.
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About the author
Jose Salloum is a Financial Security Advisor (Conseiller en sécurité financière) licensed by the Autorité des marchés financiers in Quebec, by the Financial Services Regulatory Authority of Ontario, and by the Insurance Council of British Columbia. Licensed since 2001, he works with Canadian families, business owners and incorporated professionals.
He is the founder of Canadian Wealth Creation Centre Inc. (CWCC), registered with the AMF, and of its educational branch IBCFinancial.com. He holds the Infinite Banking Concepts® Authorized Practitioner certification from the Nelson Nash Institute, a private certification rather than a regulatory licence.
CWCC is not registered with CIRO and does not provide securities advice. This page is general education and not advice on any individual file.
Important disclosures
This page is education, not advice. The content is general information prepared by Canadian Wealth Creation Centre Inc. It does not take your circumstances into account and is not a recommendation to buy, hold or cancel any contract. CWCC is not registered with CIRO and does not provide securities advice. The firm places insurance in Quebec, Ontario, Alberta, British Columbia, Manitoba and New Brunswick; clients elsewhere are served by advisors licensed in their province.
Nothing here was written with your file in front of us. Read it to understand the subject, then judge it against your own situation, ideally with someone who is licensed where you live and who has seen your numbers.
This is not tax advice, and the tax treatment depends on your own circumstances. The tax treatment described depends on the contract remaining exempt under the Income Tax Regulations and on the reader’s individual circumstances. A withdrawal, a surrender or a policy loan may be a disposition under the Income Tax Act, and amounts above the adjusted cost basis may be taxable in the year they occur. Tax rules change. Canadian Wealth Creation Centre Inc. is licensed in life and health insurance. It is not an accounting practice, it does not prepare returns, and nothing on this site is tax advice or an opinion on any reader’s tax position. Anything a reader intends to rely on should be confirmed with a professional accountant and against the current published rule of the Canada Revenue Agency and, in Quebec, Revenu Québec.
The tax result is not automatic and it is not unconditional. It rests on the contract staying within the Canadian rules and on your own situation. Before you rely on any of it, talk to an accountant who has actually worked with these contracts.
Guarantees come from the insurer, not from the government. Guaranteed values in a life insurance contract are contractual promises of the issuing insurer and depend on that insurer’s financial strength and claims paying ability. Dividends on a participating contract are not guaranteed, are declared at the insurer’s discretion and can change. Policyholder protection in Canada is provided by Assuris within its published limits; deposit insurance does not apply to insurance contracts.
The guarantees written into a contract are real, and they are the insurer’s. The dividend is not a guarantee at all; it is what the insurer decides to declare each year. Know which numbers are which before you make a plan around them.
Illustrations and projections are not predictions. Any figures, examples or illustrated values are hypothetical, are shown to explain a mechanism, and are not a forecast of the performance of any contract. Actual values will differ and may be lower than those shown. Past dividend scales do not predict future scales.
An example is there to show how the parts move, not to tell you what you will get. Any real illustration you are shown should be read on its guaranteed columns first.
Investment discussion is general and comparative. References to investment products, accounts or returns are for comparison and education. CWCC does not sell securities and is not registered with CIRO. Segregated funds are insurance contracts; their guarantees are the insurer’s and apply only at the dates and on the terms written in the contract. Returns are not guaranteed and capital can be lost.
When this site compares a contract with an investment, it is describing how each works, not telling you which to buy. Questions about securities belong with someone registered to answer them.