Annuities are a versatile option for estate planners

The current combination of low interest rates and high inflation has made annuities a more popular option for clients planning for retirement and end of life, says John Yanchus, director of tax and estate planning at Canada Life.

But financial advisors would be well advised to consider the different options and tailor annuities to specific client needs.

“I would start thinking outside the box in different areas, where to use them, or how to structure them,” Yanchus said. “They can provide a variety of options or solve a lot of problems when it comes to many areas of tax and estate planning, especially if you start thinking outside of the box.”

He said advisors and clients alike harbour misperceptions about annuities, and they tend to limit their own thinking about this “set-it-and-forget-it” investment.

Loss of principal

Yanchus said many clients mistakenly believe, for example, that when they pass away the initial principle on the annuity is lost and kept by the life insurance carrier.

“There are many options available to ensure your initial principle goes to your loved ones or a named beneficiary instead,” he said.

One example is the “return-of-premium” option that protects the investment before payments begin. If the annuitant dies before any income payments have been made, the beneficiary will receive a lump-sum death benefit equal to the annuity’s initial purchase amount. That benefit can be paid with or without interest — another protective option.

Even after payments begin, there are other options that ensure the beneficiary receives either a one-time payment equal to the initial purchase amount minus any payments already received, or they can continue the income payments until the total initial purchase amount is returned.

Flexibility

Another misperception is that annuities are inflexible. In fact, they are remarkably versatile, Yanchus said, and there are many options to increase that flexibility.

“Just two examples are cashable annuities, and the short-term rate-protection feature,” he said.

In the case of a cashable annuity, the annuitant can withdraw the full amount or part of it. The policy must be non-registered and taxed on an accrual basis and have a guaranteed period remaining.

In the case of the short-term rate-protection option, annuity payments will be increased if, on the six-month or 12-month anniversary of the policy, the increase in the Government of Canada’s 10-year bond rate is higher than a specified percentage.

Advisor misunderstandings

Yanchus said some advisors misunderstand annuities. In particular, many advisors think annuities are restricted to a single product, failing to grasp the wide range of options they can sell.

“We have options for registered accounts, non-registered accounts, life insurance policies, GIOs [guaranteed interest options], and everything in between,” he said. “Many advisors restrict their thinking to one application only, and don’t think outside of the box.”

Marketing and sales strategies

Yanchus said there are some key selling points for annuities that could help seal the deal for potential clients.

There is a settlement option form, for example, which goes hand-in-hand with the beneficiary designation, and can be changed at no cost, as long as the client is of sound mind.

“This form allows me to determine how my beneficiaries receive their inheritance, almost like me still controlling from the grave,” he said. “I can choose to provide my beneficiary with a lump sum, a term annuity, a life annuity, or any combination of the three. This is very powerful.”

That option is particularly helpful where the annuitant has a child or someone in their life who doesn’t deal well with money, is in a negative relationship, or has substance abuse issues.

“These may be examples of where an inheritance of a lump sum may cause further issues or make the issues worse,” he said. “But the ability to create a monthly cashflow through an annuity would keep them well looked after without a large influx of cash all at once.”

Another strategy involves deferring the annuity payments for up to 10 years, allowing more income-planning options.

Similarly, a person who has more assets than they will ever use themselves can set up a deferred annuity for someone else who is nearing retirement age. Not only would their own income needs be addressed, but they could also help a son or daughter prepare for retirement.

Finally, he pointed out a “copycat” strategy that allows a defined-benefit pension plan to be commuted into an annuity on a tax-deferred basis. Essentially, the total benefit of the pension plan is matched by the annuity payments and the entire amount can be transferred into that annuity, tax deferred, until the annuity payments start.

“This can be a very effective way to commute your pension and obtain the exact pension benefit without a large tax obligation arising from the non-eligible portion of the amount commuted from the plan,” he said.

“Retirees could spend several decades in retirement, so annuities are great options,” he said. “The challenge for financial advisors is how to harness their full potential.”

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This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.