Annuities Are Back in Favour

Once again popular, life annuities can replace a large portion of an investor’s bond portfolio.

Yan Barcelo 14 December, 2023 | 2:59AM
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"In an environment of high market volatility and high interest rates, life annuities are an option to consider again," says Spencer Look, director at the Morningstar Center of retirement and policy studies in Chicago. "Interest rates, he continues, are allowing annuity income levels not seen since the mid-2000s."

The figures in Quebec confirm this, showing an increase of 17.7% between 2021 and 2022. Of the six main product categories listed in the 2022 Annual Report on Financial Institutions and Credit Reporting Agents by the province’s regulator, annuities are the fastest-growing category. In the case IA, the champion with a 65% share of the Quebec annuity market, year-over-year growth was even higher, at 28%.

Yet this rise is already a year old, at a time when interest rates were not yet at their peak. Growth in 2023 promises to be even stronger. According to Jean-Francois Dufour, financial planner at Sun Life, premium income is rising steadily, although he is unable to put a figure on it. Manulife's November 20th return in the sector is revealing. The company "is currently reporting the highest annuity revenue levels among competitors," says financial planner Joël Drouin, whose firm Cabinet-Conseils Drouin & Robert is affiliated with SFL Investments.

Income Levels Vary Little Between Insurers

As Look points out, the income a retiree can expect to collect is at levels not seen in a long time. At the beginning of November, on a capital basis of $500,000, a retiree could receive an annual annuity from Sun Life of $35,496, or $2,958 per month. Such an annuity applies to a 65-year-old man who purchases a 15-year guaranteed, non-reversionary annuity from non-registered money. A 75-year-old client with an equivalent profile would receive $3,497 per month.

These amounts may vary from one insurer to another, "but the differences are minimal; the decisive factor is often a preference for one insurer or another," Drouin indicates.

A quick calculation might suggest that if a capital of $500,000 delivers an income of $35,496, this corresponds to a 7% return. But such a calculation is naïve, because we must remember a crucial aspect of life annuities: the annuitant gives his money to an insurer, who deposits it in its general reserves. This is not an investment in a segregated or other fund, for which the insurer is trustee and which provides a variable return.

In this logic, “we're talking about a 4.4% return until the end of the guarantee, explains Dufour, because the capital is disbursed, so the return is reduced" over the years. On the other hand, a retiree's longevity can change this return. "If a 65-year-old survives the guarantee and dies at 95, his rate of return has just risen to 7% or 8%," Drouin notes.  

The Various Types of Annuity Categories

The case of the 65-year-old annuitant above encompasses several sub-categories of annuities, and their differences need to be described.

  • A life annuity automatically covers the duration of a client's life. He receives income up to the time of his death.
  • Guarantees. - An annuity may or may not be guaranteed, and the term of this guarantee will generally vary from 10 to 20 years. An annuity without a guarantee is the exception, Dufour says. "If the client dies after collecting his annuity for only two years, he will have received only a fraction of it, and his estate will lose all the capital. With a 15-year guarantee, if he dies after two years, the insurer is obliged to continue paying the annuity. More often, the insurer will do so by issuing a cheque for the balance.
  • Joint and survivor. - A joint and survivor annuity provides for the transfer of annuities to a surviving spouse. Non-reversionary annuities cease upon the death of the owner. Obviously, the addition of a beneficiary adds a level of risk that will inevitably lower the annuity amount.
  • Indexation. - An annuity can be indexed to an anticipated inflation rate. The cost can be significant. With an annual indexation of 2%, the original monthly annuity of $2,958 falls to $2,416; at 4%, it yields only $1,928.
  • Prescribed or non-prescribed annuity. - The source of the original capital makes a big difference for tax purposes. In the current example, where the assets were non-registered, the annuity is prescribed, so that the interest portion is spread equally over the life of the annuity at $11,578, and it is only on this portion that the annuitant is taxed. The remainder of the annuitant's income is considered a return of capital. If the annuity is non-prescribed, the income level remains the same at $35,496, but the interest portion starts at around $23,000 and gradually declines to around $13,000 in 2041 as the capital decreases. Prescribed or non-prescribed, both evoke Lafontaine’s fable of The Ant and the Grasshopper, Drouin explains. The former gives you more income at the beginning, with which, like the carefree grasshopper, you can "celebrate", while the latter reserves more income for later on, at an age when health care needs, for example, may be greater.
  • Deferred annuities. - You can reserve your annuity and all its conditions in advance, a period that usually does not extend beyond two years, but can go up to five. For example, at age 57 you can determine what will be your level of income starting at age 60. "It's a nice feature, Look says, but you're locked into that; you might be frustrated because in the meantime rates have gone up."

Who Should Buy an Annuity?

Annuities can appeal to a wide range of people, but "they are generally more appropriate for people in good health who can expect to live a long time," Look says. Annuities reduce longevity risk.

Of course, you can't put all your eggs in one basket. Dufour suggests acquiring an annuity that will cover all or part of recurring basic expenses (rent, heating, taxes, food, etc.). Since the annuity takes care of the basics and helps provide security for the retiree, he or she can allocate other sources of income to variable leisure and travel expenses.

According to Look, an annuity can easily replace a large part of the bond portion in a portfolio. "You can then reserve a good chunk of the portfolio for more growth-oriented investments." A good time to acquire an annuity is when you receive a large cash inflow, for example when you sell your house to move into an old-age residence.




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About Author

Yan Barcelo  is a veteran financial and economic journalist with more than 30 years of experience, Yan writes for many publications in Toronto and in Montreal, including CPA MagazineLes Affaires and Commerce.

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