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Volatile markets and still-high interest rates have sparked renewed interest among clients in annuities, which provide a stable income in the long term and can help mitigate longevity risk.  

For example, payout annuities can replace the income security provided by defined benefits pension plans that are becoming rarer in Canada, said Paul Savage, head of individual insurance at Manulife in Toronto. 

But the products are still not well understood by clients, so advisors should be prepared to address common client fears — such as losing their money if they die early, and interest rate and inflation risks. 

Guarantees 

“The biggest misconception about annuities is that if you buy an annuity and you die tomorrow, all your money disappears,” Savage said. “And that is really not true.” 

There are different guarantee options that can protect the value of the annuitant’s premium in case of an early death — but adding guarantees will decrease the value of annuity payments. 

While a term annuity is guaranteed for its duration, guarantees for life annuities are optional. A capital protection guarantee returns the difference between payments received before death and the initial capital to a beneficiary.  

A guarantee can also be issued for a specified number of years so a beneficiary can continue to receive annuity payments until the end of the period. If an annuitant dies before a deferred annuity begins payments, a return of premium guarantee will ensure the full deposit is refunded. 

Advisors need to know what the client’s goals for the annuity are before they can recommend the right combination of guarantees, said Kevin Hwee, vice-president of product design and pricing in wealth solutions with Canada Life in London, Ont. 

Clients can choose shorter guarantee periods if they’re looking for higher income, or higher guarantees if it’s important to leave a legacy, Savage said. 

Des Nwaerondu, a financial planner with Sun Life and president of Tusk Financial Services in Calgary, suggests advisors use illustration software to model the outcomes of each situation to show the client how guarantees can impact payments and what beneficiaries get if they die early. 

Interest rate and inflation risk 

In addition to losing their capital, clients might also fear inflation will erode future annuity payment values, Savage said.  

To preserve the value of payments over time, clients can add a rider to an annuity that increases payments annually by a fixed percentage or a percentage tied to the consumer price index, Hwee said. 

Although this will lower the initial payment, the increasing payments can help the annuitant plan for the same income level over time, Savage said. 

As annuity returns are tied to the interest rate at the time of purchase, clients may think they’re not getting a good deal on an annuity when interest rates are low, Savage said.  

Advisors can speak to clients about five years ahead of their planned retirement date to figure out how much of an annuity they need. To mitigate interest rate risk, they can make multiple annuity purchases over time, Nwaerondu said. They can buy a deferred annuity now and monitor interest rates to buy more if rates increase. 

Post-mortem tax deferral on registered retirement funds 

If a client has an RRSP nearing maturity, buying an annuity with some of the funds means income tax will be deferred, Savage said. He suggests advisors use illustrations to show clients the financial impact of tax deferral. “It can be a really nice way to smooth it out and avoid a big one-time tax bill.” 

Another way to defer tax through an annuity is buying a T-18, or term-to-age-18, for surviving children with RRSP or RRIF funds. A T-18 can be set up for financially dependent children under age 18 who receive proceeds from the RRSP or RRIF of a deceased parent or grandparent. Payments are taxed at the child’s marginal tax rate. 

A T-18 could be a good option for clients with no surviving spouse as their RRSP or RRIF would not benefit from spousal rollover when they die, Nwaerondu said. 

Hwee suggests advisors refer their clients to an accountant to work out the nuances of tax implications. 

Two ways to use an insured annuity 

An insured annuity uses a life annuity contract to fund a life insurance policy. When the two products are bought at the same time, the upfront cost of the annuity is typically much lower than the life insurance’s death benefit. 

This could be a good option for clients who want to leave a legacy in a tax-free death benefit that bypasses probate, but “99% of clients don’t know about it,” Nwaerondu said. 

Alternatively, an older client with an existing insurance policy can buy an annuity to cover payments for the remainder of their life, Savage said. The insurance premiums would have been lower if they bought the policy when they were younger and in good health, while the annuity payments will be higher later in life. 

“This can be a good option for someone who is conservative or someone who wants to guarantee that they’ll be able to cover the life insurance premiums,” Savage added. “They don’t need to have planned this strategy upfront. If they’ve got a life insurance policy in place, they could purchase an annuity at any time.”