Annuities can form a great source of income, especially for those looking for regular and structured retirement income. However, just because it is considered widely as a form of retirement income does not necessarily mean annuity payments are not subject to tax.
Hopefully, by the end of this article, we’ll have helped you in making a more informed decision when it comes to investing in annuities.
What Are Annuities & How Do They Work?
Similarly, you can choose to receive income payments over a fixed period or for life. You would receive payments on a monthly, quarterly, bi-annual, or annual basis, and the payments you receive will usually be a combination of a return on your capital investment, interest, and, possibly, a transfer of capital from annuity holders who have died earlier than statistically expected.
Exact amounts of payments would vary from person to person, and depend on several factors. These include gender, age, health at the time of investing, the type of annuity, the length of time of payments, rate of interest, and any terms set by the provider of the annuity.
There are many different types of annuities, but for today’s discussion, we’ll be limiting it mainly to four different types. These are life annuities, fixed-term annuities, registered annuities, and non-registered annuities.
Life annuities provide lifetime guaranteed income from the age of retirement until your death. Upon your death, there would be very limited options for transferring over the benefit to your surviving heirs. Otherwise, all payments will stop upon your death.
Fixed-term annuities offer income for a fixed period. In the event of your death, the benefit would transfer over to your heirs or estate for the remaining term of the annuity.
We’ll discuss registered and non-registered annuities in more detail when discussing the tax implications of annuities, as tax is the main differentiating factor between the two.
What Are The Tax Implications of Annuities in Canada?
Canada has a graduated tax system, which means the amount of tax you need to pay is determined by how much money you’ve made in the year.
In a nutshell, most types of income are taxable, and the same is true for annuities as well.
Taxation on annuity income depends on whether the annuity is registered or non-registered. For registered annuities (which include annuities purchased with registered mutual funds or pension funds) all income is taxable.
For non-registered annuities, there are three different tax treatments. These are prescribed taxation, accrual taxation, and level taxation.
Prescribed taxation would apply to prescribed annuity payments i.e. payments that are a level blend of interest and capital investment. This means only a fixed portion of the payment would be taxable. Some other conditions need to be met for an annuity to be categorized as a prescribed annuity payment.
Accrual taxation, also called non-prescribed taxation, is when the interest earned in the annuity is taxable only. The interest earned from the purchase date to the policy anniversary is taxed, following which the annual interest earned is taxed. This results in higher tax payments in the beginning years of the payments, which go down as more and more payments are made.
Level taxation applies to policies that have been issued before 2nd December 1982, and taxable gains from such a policy are only taxable once the policy is annuitized or surrendered.
How Can I Invest In Annuities?
Annuities are like most financial products and the easiest way to invest is to get in touch with a life insurance company. It would be best to see multiple options and not buy from the first life insurance company you contact.
You’ll also find brokers who will offer products from various insurance companies. They’ll give you a comparison between your options and help you choose the right one for you.
Are Annuities Taxed?
Like most forms of income in Canada, annuity payments are also subject to taxation. Different tax treatments apply depending on the type of annuity, but at the very least you should expect to be taxed on the interest component of the payments that you’ll be receiving under your annuity plan.
Are There Ways to Minimize Tax on Annuities?
There are many ways to minimize the tax impacts on annuities. The most common and effective strategies include splitting income or qualifying for a pension income tax credit.
Ways To Minimize Tax On Annuity Payments
Annuities can be a great source of income in retirement and some annuities may even offer a sizable payout. Making an annuity a part of your portfolio could go a long way in not only diversifying it but also offering you security for your golden years.
The question does arise of how one could go about minimizing the tax impact. One of the simplest ways of doing so is income splitting, whereby you’d transfer income from the annuity to your spouse or other family member who may be eligible under the annuity policy.
Another way is to claim a pension income tax credit, provided your annuity payments qualify for this credit. However, you should note that the credit amount is capped at $2000.
Consulting With The Experts!
It might also help to speak to an expert regarding tax planning for Canadians. We at Eastport Financial are well-versed in dealing with all types of financial products and their inherent tax implications.
Our experts Halifax Financial Advisors can guide you on how to best grow, protect, save, and adapt your income, investments, and retirement savings so you end up paying the least tax possible.