24.4.4 Deferred Annuities
Overview
An annuity is an investment contract through which the holder deposits money to be invested in an interest-bearing vehicle. Deferred annuities differ from immediate annuities in that payments to the holder start at a date specified by the investor in the contract, whereas with immediate annuities, payments start immediately. Both types can be paid in full at the beginning or through monthly instalments until the payments begin.
Key Features
- Investment Contract: The deposited money is invested in an interest-bearing vehicle.
- Interest and Capital Return: Annuities provide returns both on interest and a portion of the initial capital.
- Deferred Payments: Payments from deferred annuities start at a specified future date.
Tax Implications
Non-Taxable Contributions: Contributions to a deferred annuity are not tax-deductible.
Taxable Interest: The annuitant is taxed solely on the interest portion, not the capital.
RRSP Annuities: If registered as an RRSP, contributions are tax-deductible, and proceeds are fully taxable.
Annual Taxation: Interest earned during the accumulation phase outside a registered plan is taxable annually.
Transfer of Benefits
- Spouse Transfer: On the death of the annuitant, benefits can transfer to the spouse.
- Children and Grandchildren: The benefits may be transferred to financially dependent children or grandchildren, with the potential for tax-exempt transfers to eligible annuities, RRSPs, or RRIFs.
FAQ
Q1: How does a deferred annuity differ from an immediate annuity?
A1: In a deferred annuity, payments start at a later date specified in the contract, whereas immediate annuity payments start right away.
Q2: Are contributions to a deferred annuity tax-deductible?
A2: No, contributions to a deferred annuity are not tax-deductible.
Q3: What happens to the annuity if the holder dies?
A3: The benefits can be transferred to the spouse or, under certain conditions, to a financially dependent child or grandchild.
Q4: Can deferred annuities be registered as RRSPs?
A4: Yes, some deferred annuities can be registered as RRSPs, making the contributions tax-deductible.
Glossary
- Annuity: A financial product that pays out a fixed stream of payments to an individual, primarily used as an income stream for retirees.
- RRSP (Registered Retirement Savings Plan): A retirement savings plan that provides tax advantages for retirement savings in Canada.
- After-Tax Income: Income remaining after deducting taxes.
Key Takeaways
- Deferred annuities are investment vehicles providing future income streams.
- Contributions are not tax-deductible unless registered as an RRSP.
- Upon death, benefits can transfer to a spouse or dependent children/grandchildren.
- Deferred annuities are exclusively available through life insurance companies.
📚✨ Quiz Time! ✨📚
## What is a key characteristic of a deferred annuity?
- [ ] Payments to the holder start immediately.
- [ ] The annuity is only paid for in full at the beginning of the contract.
- [x] Payments start at a date specified by the investor in the contract.
- [ ] Contributions are tax-deductible.
> **Explanation:** With a deferred annuity, payments start at a future date specified in the contract by the investor, unlike immediate annuities where payments begin immediately.
## How are contributions to a deferred annuity treated for tax purposes?
- [ ] They are tax-deductible like RRSP contributions.
- [x] They are not tax-deductible and do not reduce current taxable income.
- [ ] They are exempt from taxation entirely.
- [ ] They increase the current taxable income.
> **Explanation:** Contributions to a deferred annuity are made with after-tax income, and thus, unlike RRSP contributions, they are not tax-deductible.
## How is the annuitant taxed on the payments from a deferred annuity?
- [ ] The entire payment is taxable.
- [x] Only the interest element of the payments is taxable.
- [ ] The capital portion of the payments is taxable.
- [ ] None of the payment is taxable.
> **Explanation:** The annuitant is taxed only on the interest element of the annuity payments, not on the capital portion because the initial investment was made with after-tax income.
## What is the tax treatment of deferred annuities bought with RRSP funds?
- [x] The full annuity payment is taxable.
- [ ] Only the interest element is taxable.
- [ ] The payments are not taxable.
- [ ] They are partially taxable on a sliding scale.
> **Explanation:** For annuities bought with money from RRSPs, the full annuity payment is taxable since the principal cost was tax-deferred when initially contributed to the RRSP.
## What happens to the deferred annuity benefits if the annuitant dies?
- [ ] The benefits are lost.
- [x] Benefits can be transferred to the spouse of the deceased annuitant.
- [ ] Benefits must always be included in the deceased’s income in the year of death.
- [ ] They are transferred to the government.
> **Explanation:** Upon the annuitant's death, benefits can be transferred to the annuitant's spouse, or in some cases, to a financially dependent child or grandchild.
## Under certain conditions, who else can receive the benefits of a deferred annuity if the annuitant dies, apart from the spouse?
- [ ] Only the executors of the will
- [ ] Any family member
- [ ] Charitable organizations
- [x] Financially dependent children or grandchildren named as beneficiaries
> **Explanation:** Under certain conditions, benefits may be taxed in the hands of financially dependent children or grandchildren who are named as beneficiaries.
## What options do financially dependent children or grandchildren have receiving deferred annuity benefits?
- [ ] They can only receive cash payments.
- [x] They can transfer the benefits to an eligible annuity, an RRSP, or an RRIF.
- [ ] They must pay a penalty before receiving the benefits.
- [ ] They can disregard the benefits.
> **Explanation:** Financially dependent children or grandchildren can transfer the benefits to an eligible annuity, an RRSP, or an RRIF.
## Where are deferred annuities available?
- [ ] Through banks
- [ ] Through investment brokers
- [x] Only through life insurance companies
- [ ] Through any financial institution
> **Explanation:** Deferred annuities are available exclusively through life insurance companies.
## Why are deferred annuities usually purchased with registered funds?
- [ ] Because unregistered funds do not earn any interest.
- [ ] Because the capital portion is entirely tax-exempt.
- [x] Because the interest earned during the accumulation phase is taxable on an annual basis outside a registered plan.
- [ ] Because the funds do not need to be declared.
> **Explanation:** Deferred annuities are typically bought with registered funds because the interest earned during the accumulation phase is otherwise taxable on an annual basis outside a registered plan.
## Can a deferred annuity be registered as an RRSP?
- [x] Yes, within RRSP contribution limits.
- [ ] No, it cannot be registered as an RRSP.
- [ ] Only under certain conditions.
- [ ] Yes, but only partially.
> **Explanation:** Some deferred annuities may be registered as RRSPs, and investments in such annuities, within RRSP contribution limits, are tax-deductible when contributed, making the proceeds fully taxable.