c emptor wrote:I recently received an annuity quote from an insurance company which stipulated that the quote was offered "Assuming your marginal tax rate is 50%". Why does the recipient's tax rate influence the quoted amount? I got a quote from another insurance company that didn't mention this qualification.
I asked for a "prescribed" quote and found that about 25% of the money received was taxable. The rest would be return of capital. Is this prescription amount influenced by the recipient's marginal rate?
A prescribed annuity is a tax-driven creature. It can be purchased only with non-registered funds. And it can't be inflation-indexed.
Every life annuity payment received is a blend of taxable interest and tax-free return of capital. Think of it like a home mortgage. In the early years there's a lot of interest. As each year goes by, the level of interest falls as the level of principal repaid goes up. So, with an annuity that's NOT prescribed -- such as one bought with RRSP/RRIF money -- there's a lot of taxable interest early on.
Under the prescribed annuity rules, CRA lets the issuing insurer
level the interest-RoC split over your life expectancy. So in the early years there's a lot less taxable interest and a lot more tax-free RoC. At some point, the table turns and the levelling pays out more taxable interest and less RoC than you'd get with a straight annuity. But many/most people die before then. Or are too infirm to care.
Thanks to this levelling, a prescribed annuity can usually produce more spendable income than GICs or bonds. But unlike GICs or bonds, it's a lifetime contract with no access to the underlying capital.
The financial industry norm is to use a 50% MTR for generalized illustrations. That goes back to when the top bracket MTR was about 50%. And the math is easy. Any financial advisor who sells annuities can easily produce an illustration using your actual MTR. BTW, a life annuity is an insurance contract and can be purchased only from a licensed advisor. BTW#2: It's important to shop the market for a life annuity quote. At various times an insurer might not want new annuity business, but instead of withdrawing from the market it just gives lousy quotes.
Nowhereman wrote:I assume that when you die, the annuity dies, unlike the ownership of the bonds, they are what the next generation inherits, after taxes??...The couple whose monies I allocated for them do not even spend their pension monies and leaving an Estate to their only child is of paramount importance, sounds like an annuity would not work for them.???
Before this couple considers annuitizing, they should ask these questions:
1. Does our pension income cover our normal living expenses?
2. If so, how secure is the pension promise? IOW, what are the odds that the plan sponsor will go bust and leave an unfunded liability?
3. How well is our pension protected from inflation? Few private sector pensions are indexed at all. Indexing is common for public sector pensions, but often not full indexing.
If the pension meets their normal living expenses, the sponsor is public sector, and there's full inflation indexing, they have no need for an annuity. If there's not full inflation indexing, can they reasonably generate enough investment income to cover that gap? If so, they have no need for an annuity.
If, for some reason, they really want to annuitize but also want to leave an estate, they can look into a "back to back." Here, the advisor matches a life insurance policy to the annuity. Let's say the annuity costs $100,000. The life insurance would be placed for $100,000. So mom and dad get to spend their cash flow and the original capital amount is still available at death thanks to the insurance payout. This is most often done with a prescribed annuity that can only be purchased with non-registered funds. The idea is that part of the extra cash flow relative to after-tax GIC/bond interest will be used to pay the insurance premium.* Whether this works will depend on the age and health of the couple.
The life insurance premiums really should be paid by the estate beneficiaries since they'll get the benefit. But one of Canada's top financial advisors told me years ago that he had almost no retiree clients who went for that. Even if the parents were willing, the selfish kids weren't.