Annuities

In this post I will talk about Annuities, something that many people have heard about, but don't really know how it works. Annuities aren't as popular today as they used to be, because of all the different types of investments we have today, but they can still be used as a key part in someones portfolio.

Annuities are considered an Insurance contract, and therefore can only be offered by Insurance companies - which could be one reason that they are not known or used as often as other products. There are several different types of annuities, and they can have a few different features added to them as well, so I will explain the details of each below. Before I get to that, I will give a brief definition of what an annuity is, in general.

What is an Annuity?

Here's a definition I got from the Manulife website, which I think is simple but gets the point across.

In exchange for a single lump sum investment, an insurer makes guaranteed regular income payments to an investor that contain both interest and a return of principal. Annuity payments can continue for the lifetime(s) of one or two people, or for a chosen period of time.

(Source: Manulife.ca)

Annuity is often used in retirement portfolios, to give the Annuitant a regular and known stream of income. The concept is similar to that of a pension - when you retire, you start to receive a regular income stream, however, it is not always known. With an annuity, you will know exactly how much income you're receiving on a regular basis. You can purchase an annuity with either registered or non-registered funds, and have your tax rate prescribed (where you know exactly how much taxable income you're going to receive every year) or non-prescribed (every year you pay different amount of tax on your income.

First I'll go through the pros and cons of annuities, and then I will go into the main different types of annuities.

Pros

- receive a regular income stream

- income stream is known

- minimizes taxation of income (because it is returned as principal and interest)

- there is no market risk (you continue to receive regular stream of income even if the markets tumble)

- payments can continue to a beneficiary even after death

- can know exactly how much taxes you're paying

- can be indexed for inflation

- can be set up as single or joint

- generally higher returns than other products (i.e. GICs)

Cons

- very little flexibility - once the money is given to the insurance company, usually, you no longer have any access to it

- if you want to add a cashable component to your annuity (where you can take some of your regular principal as a withdrawal), this will reduce your income stream

- adding features (i.e. payments continuing after death, or index inflation) will reduce the amount of income you receive

- income stream is lower for younger clients

- do not take advantage of market gains

As you can see, there are still drawbacks to using this type of product, and it is not seen as something that might fit into every persons portfolio.

Now that you get a general idea of what Annuities are and how they function, I will now go through the main different types of Annuities offered in the industry.

Single Life - This is fairly self-explanatory. The annuity is issued to a one person, and the annuity payments will continue until the annuitant dies, at which point, they will stop.

Single Life with Guarantee - With this, you can set up a guarantee period (usually 20 or 25 years, or up to age 90, whichever comes first), which means, if you die within this guarantee period, the payments will continue to a named beneficiary until the end of the guarantee period. The longer the guarantee period, the less your income stream will be.

Joint-Life - The payments will continue until the death of the surviving spouse. You can add a 'reduction' feature which will reduce the amount of income received by the surviving spouse upon the death of the first spouse (usually reduced to 40% or 50% of current income stream). By adding this feature, you can increase your current income stream until the death of the first spouse.

Joint-Life with Guarantee - Same as above, but can also add a guarantee period (usually 20 or 25 years, or up to age 90, whichever comes first), so the payments can continue to a named beneficiary (or estate) upon death of the second spouse.

Term Certain - This type of annuity will provide you with a guaranteed income stream for a set number of years (to a maximum of 25 years or age 90, whichever comes first). After this period is complete, the payments stop. If you pass away during this period, the payments will continue to a named beneficiary.

As you can see there are several different types of annuities offered, all with certain features and benefits. One or more of these can fit very nicely into a retirement portfolio to provide you with a regular stream of income, which can help you to maintain your current standard of living and lifestyle. That being said, by no means should you put your entire savings into this type of vehicle. This product should make up only a portion of your retirement plan, and should be used together with other strategies/products.

I hope you have learned some good things from this post, and please consult your financial advisor before making any decisions on how this product might fit into your portfolio. If you have any questions or comments, please do not hesitate to contact me!