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7 things that affect annuity income

by Tim Weichel

Your annuity income is calculated at the time you buy the annuity. It’s based on a number of factors. The most important ones are your life expectancy and interest rates. If you’re buying a life annuity, the insurance company uses insurance tables to project how long you are likely to live.  Factors that will affect your annuity income.  

1. Your age

The older you are when you buy the annuity, the higher your annuity payments will be. That’s because you’re not expected to live as long.  The best time to buy an annuity is between the age of 60 and 71.  The older you are, the more that your age affects the rate you will get. 

2. Current interest rates

If interest rates are high when you buy your annuity, your annuity payments will be higher than if interest rates were low. That’s because the financial institution predicts it can earn more by investing your money.  The older you get, the less important the interest rate is in determining your payout, compared to the importance of your age. And as people are living longer, the effect of higher future interest rates may be offset by lower rates due to increased life expectancy.  One strategy that can be used to mitigate this effect is to ladder your purchase of annuities – in other words – buy several annuities over a period of several years.

3. Your gender

Women get less money than men of the same age because they are expected to live longer.

4. The amount you deposit

The more money you put into your annuity, the more you get back as income.

5. The length of time the payments are guaranteed

 If you have a life annuity, you can arrange for your annuity payments to continue to your spouse, your dependent children, or your estate after you die. The longer you want payments to continue after your death, the less you get each month while you’re alive.

6. The options you add​

You get the highest income with a basic annuity that covers only you. Any options you add (like a joint-and-last survivor option) will lower the amount of your payments. That’s because these extras increase the costs to the insurance company.

If interest rates are low when it’s time to convert your RRSP into an income option, you may want to delay buying an annuity. Instead, you can open a RRIF.  You can then use your RRIF to buy an annuity, or you can consider laddering your annuities as described earlier.

7. If you have a serious medical condition

Some life annuity providers will also factor poor health into an annuity quote if you have a serious medical condition. This means your annuity payments will be higher because your life expectancy is shorter.

Paying tax on your annuity income

If you buy an annuity with money from a registered plan

If you buy an annuity with money from a pension plan, RRSP, or RRIF, your annuity payments will be fully taxed. That’s because you’re buying the annuity with pre-tax dollars.

If you buy an annuity with non-registered money

You’ll only pay tax on a portion of the payments you receive. That’s because you have already paid tax on this money. Here’s how it works:

  • To make your regular payments, the annuity provider pays out some of the income it earns investing your money, together with some of your original principal.
  • In the early years of your annuity, the Canada Revenue Agency (CRA) considers most of the income you get as interest for tax purposes. That means it will be fully taxed.
  • In the later years, the income you receive is mostly from your principal. Since you have already paid tax on that money, your taxes go down over time.

Deferring tax on annuity income

One way to defer paying tax on your annuity income is to buy a prescribed annuity with after-tax money. The annuity provider will include the same amount of principal and interest for each payment. This evens out the portion of your payment that is subject to tax, and means you pay less tax in the early years.
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