What is an insured annuity?
An insured annuity is a financial strategy used to maintain a steady income during retirement but at the same time preserve the value of your estate for your heirs. With this strategy, you use your existing interest-bearing funds and investments to purchase a life annuity and a permanent life insurance policy on yourself. You receive a guaranteed income for life from the annuity, which then goes toward paying the premiums on the insurance policy, to income tax and to lifestyle expenses. (It is also possible to pay for the insurance policy with a single payment.)
The strategy can use term-to-100, paid up at 100 or universal life insurance plans. When you die, the beneficiaries of the life insurance policy receive the insurance proceeds – tax free.
What are the benefits of an insured annuity?
The combination of the annuity and the life insurance policy essentially creates a life-long, locked-in, risk-free, fixed-return investment and a guaranteed inheritance for your heirs. The annuity will provide a better income than other fixed-rate investments such as GICs and term deposits while preserving capital. This approach can relieve worry about the conflict of needing to use your funds in retirement – and possibly outliving your money – but also wanting to leave a significant estate to your heirs.
Because the bulk of your estate will pass to your beneficiaries through insurance proceeds, income tax and potential capital gains tax on the value of your estate will be eliminated. Probate fees will also be reduced, thus ensuring that your heirs or the charity of your choice receive as much as possible. Another benefit is that the life insurance proceeds are protected from any creditors of your estate.
The fact that the value of your estate will pass via an insurance policy means that both you and your beneficiaries know in advance what the value of the proceeds will be and that the value is guaranteed.
Because a portion of your income will be through an annuity, rather than from investment income, it will be predictable. Investment income can vary widely. In addition, your annual after-tax income will be greater from the annuity than it would be from investment income.
You will also save income tax. Investment income will be fully taxable at your marginal tax rate, but annuity income is taxed at a lower rate because it is seen, in part, as a return of your principal investment to you – only the interest portion is taxed. This lowering of your taxable income also helps to protect your income from the Old Age Security clawback.
Who should use this strategy?
Buying an annuity works best when you are over the age of about 65 because the payments will be higher: generally, the older you are when you buy the annuity, the larger your annual or monthly payment will be. You should also be in a secure financial position such that you will not need to change the strategy because it is irrevocable. The strategy makes the most sense for investors with non-registered investments available to put towards the strategy. Because you will be purchasing a life insurance policy, you need to be in good enough health to qualify.
It is also possible for a corporation to use the insured annuity strategy to gain tax benefits. In this case, the insurance policy is most often on the life of the principal shareholder and the annuity payments go to that person. In this scenario, the question of share valuation comes into play, so discuss it with your business advisor and tax planner.