Montreal Gazette

Annuities bring gains from sale of house

Series of monthly payments can be made for life

- IMRAN SYED Imran Syed is an independen­t, fee-only certified financial planner.

Q: We are selling my mother’s house and had heard about a strategy using a prescribed life annuity instead of a GIC. How does it work? She is 79 and quite risk averse.

A: With an annuity, you turn over a lump sum of cash in exchange for a series of monthly payments. Life annuities make these payments for as long as you live and are issued only by insurance companies. Term-certain annuities are for set terms and issued by insurance companies, banks, trust companies and credit unions.

Every annuity has two parts: taxable interest and tax-free return of capital. With a normal annuity, payments in the early years are mainly interest. Prescribed annuities differ in that each payment is an equal part of capital and interest. This results in significan­t after-tax advantages over GICs because of their design and tax treatment.

Let’s assume your mother has $200,000 of capital from the proceeds of her house. If invested at three per cent, a GIC will pay about $6,000 in annual interest. But that’s fully taxed, so if your mother is in a 40 per cent tax bracket, she’ll net $3,600 per year.

For a prescribed annuity, $200,000 would provide an annual income of about $17,000 from a well-rated insurer (at the time this article was written). However, this is where the prescribed annuity really shines. As only about $1,385 of the income is taxed, this provides an after-tax annual income of about $16,450. This is $12,850 more per year than the GIC, assuming your mother is in a 40 per cent tax bracket.

This is equivalent to the after-tax income from a GIC earning over 10 per cent.

Although this is significan­tly higher than the after-tax GIC payout, to be fair, we have to incorporat­e another comparison. The GIC pays periodic interest and returns all capital at maturity.

The annuity returns capital with each monthly payment, and with a life annuity,

Prescribed annuities result in significan­t after-tax advantages over GICs.

nothing is returned to the estate upon death. Most life annuities do contain the option for a guaranteed minimum number of payments, to allow for at least a partial return of capital, if the annuitant dies prematurel­y.

In your mother’s case, she can probably get a payment guarantee to age 91, so that in the event of her premature demise, the commuted value of remaining payments are paid out directly to her beneficiar­ies.

Another option might be to purchase a term-to-100 life insurance policy, but we would have to factor in the cost of premiums and whether your mother could qualify for the coverage medically.

Finally, consider liquidity and inflation. GIC investors can get access to their capital at each renewal. And if interest rates rise, at renewal, an increased interest rate is offered. A prescribed annuity ties up your capital and is not indexed for inflation. As well, prescribed annuities can only be purchased with non-registered funds. A prescribed annuity may be considered as an anchor for your mother’s income stream, but not as the only component. Consider having other funds available for liquidity.

This article provides general informatio­n and does not constitute financial or other profession­al advice. Seek independen­t advice before implementi­ng any of the strategies.

Newspapers in English

Newspapers from Canada