Retirement Mistake No.30: Not Cutting Seniors’ Tax with Prescribed Annuities
Posted In: Retirement Planning for Entrepreneurs

If you’re more than 65 years of age and looking for a low-risk way to reduce taxes on retirement income while boosting your monthly cash flow, you might want to consider prescribed annuities. The word “annuity” can scare off a lot of people because in the past most annuities died with the person who set them up. Today, however, insurance companies hungry for retirees’ business offer a range of flexible annuities, some having guarantees for beneficiaries for ten and fifteen years of payments.

The plan is simple. You lock away a fixed amount of money in return for income for life. You can set up individual or joint annuities with your spouse. Then, you set a guaranteed beneficiary payment period, say five or ten years from the start date of the annuity, for after your death. The key here though, often overlooked, is taxation. If you’re getting clawed-back old age pension and you see your income diminish and your quarterly income tax installment bill rising, consider an annuity for part of  your income. The annuity reduces the amount of taxes payable because it “amortizes the investment income over the life of the annuity.”

If your spouse is in a high tax bracket and generates a lot of interest income, annuities can reduce the tax bill. Most professionals recommend annuities, but usually to a maximum of 25% of your investment portfolio. The ideal investor is usually past the age of 70 and is paying tax installments quarterly or has large income tax deductions from retirement income.

But not all investors are older than 70. Some annuities work well with people in their 60s, who can sometimes qualify for insured annuities, which guarantee the principal amount tax-free to beneficiaries upon death. You can do this by purchasing a life insurance policy. Insurance companies also allow you to purchase insurance on a smaller amount of the principal. Talk to your financial professional to see if annuities might help boost your income and reduce your tax bill.

Why would Dave, a 72-year-old retiree from Qualicum, switch his RRIF to an annuity? Retirement income planning tells us that the primary aim of most of our investing is to provide income for when we can no longer earn it. To maximize this future income we try to maximize the growth of our investments while minimizing any risks. Dave looked for a secure, stable income that he cannot outlive; but when he switched from accumulating investments to drawing on them he discovered that the income from most is both erratic and temporary. Interest rates and dividend levels change; GICs and bonds mature; and we have to seek other investments.

For Dave, a joint life annuity will address his and his wife’s income needs for as long as either of them are alive. This is just one of the reasons why Dave switched. A few of the others are capital erosion, level income, mortality, simplification, insurance, and permanence. Here is Dave’s thinking behind each reason.

Capital erosion–Last year Dave’s RRIF earnings averaged only 5.69% while the mandatory minimum withdrawal was 7.38%. As the payout became higher than the profit, the difference had to come from capital. Also, as the minimum withdrawal rate keeps increasing, until it levels out at 20%, the capital erosion will keep increasing. The capital will eventually exhaust itself, eaten up in its final years by the fees of the RRIF trustee.

Level income–Dave wanted a level monthly income for life.

Mortality–Dave or his wife can easily outlive a level RRIF income. However, they can’t outlive the income from a joint life annuity.

Simplification–Accumulating investments accumulate paper. There’s a great quantity of data about them–certificates, statements, records, etc. It is a chore just to keep track of them all.

Insurance–The purpose of most life insurance is to provide a lifelong income for one’s widow. A joint life annuity does exactly that.

Permanence–A life annuity is permanent.

There are a lot of seniors like Dave who haven’t thought of the advantages that an annuity has over a RRIF. Are you one?

Nowadays some people expect the door of opportunity to be opened with a remote control. – Charles Wheeler

If you can give your son or daughter only one gift, let it be enthusiasm. – Bruce Barton


Published with permission from Grant Hicks

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