Consider Prescribed Annuities Before Tax Changes in 2017

When you buy a life annuity, you receive a guaranteed stream of income for as long as you live and do not have to worry about the fluctuations of the markets and interest rates. Plus, life annuities provide the highest level of guaranteed income available.

If you buy a life annuity with non-registered money, it may qualify as a prescribed annuity and be eligible for preferential tax treatment.

Income Tax regulation 304 prescribes that certain annuity contracts are exempted from accrual rules (where all growth has to be taxed annually) when it comes to their income reporting requirement, hence the term, “prescribed annuities”.

While non-registered prescribed annuities have always served as a very tax-effective source of guaranteed retirement income for Canadian retirees, with tax changes coming January 1, 2017, it makes even more sense to consider them now before their tax benefits are reduced.

Annuity payments are based on life expectancy. The longer the life expectancy of the annuitant, the smaller the annuity payments would be and vice versa, the shorter the life expectancy, the bigger the payments.

Currently, the life expectancy rates used for non-registered prescribed annuities are based on life expectancy rates included in the 1971 Individual Annuity Mortality Tables (IAM). Based on new changes to the Income Tax Act, starting in January 1, 2017, life expectancy for prescribed annuities will be updated and will be based on the Annuity 2000 Basic Mortality Tables. Since longevity has increased in the past few decades, the new tables include longer life expectancies. Since annuity payments are a blend of return of capital and interest, this will reduce the portion of each payment that will be treated as a return of capital, as the principal portion has to be spread over a longer period.  As a result, each prescribed annuity payment on contracts purchased after January 1, 2017 will have a higher taxable portion.

The following table shows the impact of the new rules on annuity payments:

The above-noted figures are based on Sun Life quotes for a $100,000 premium with a 10-year guaranteed period, a purchase date of July 1^st, 2015, and an income start date of August 1^st, 2015. This is for illustrative purposes only – different annuities will result in different variations in taxable portions from old to new.

If you purchase a prescribed annuity on or after January 1, 2017, the new life expectancy table will be used to calculate the taxable portion of each payment.  However, if you purchase an annuity before January 1, 2017, the old tables will still be used to calculate the income stream, even if the annuity payments don’t start until after January 1, 2017. This “grandfathering” provision is a good reason to seriously consider prescribed annuities as a source of tax-effective guaranteed income during retirement.

Therefore, if you are contemplating the use of prescribed annuities in your financial and retirement planning, you should discuss the impact of these changes with your financial advisor and try to make a decision before the end of 2016 to be able to take advantage of the existing preferential tax rates applicable to prescribed annuities.