Is It Time to Revisit Prescribed Annuities for Retirees?


(From the October 2022 Edition of eFORUM)

By Kevin Wark


Until recently, low interest rates and vibrant stock markets have made non-registered life annuities a hard sell for most retirees. However, with the dramatic increase in interest rates, the “boom” in retirements, and longer lifespans, now may be a good time for you to explore the benefits of prescribed annuities with your older clients. A prescribed annuity can be used to provide guaranteed lifetime income as well as preferential tax treatment.

For the uninitiated, a prescribed annuity is a non-registered payout annuity issued by life insurance companies (and other specified financial institutions) that meet certain conditions set out in the Income Tax Act. These rules govern who is entitled to own and receive payments under the contract. For example, corporations and most trusts cannot own a prescribed annuity. The regulations also specify the type and duration of payments that can be made under the annuity. This type of product is often used to convert non-registered fixed income assets into a stream of retirement income payable for the lifetime of the individual or the individual and his or her spouse.

Payments under the annuity represent a return of the original deposit plus interest income. However, the original capital that is used to purchase the annuity is treated as being returned on an equal basis over the exepected life of the annuitant(s). The capital amounts are received tax-free by the annuitant with the excess being treated as interest income. This means that the initial annuity payments are subject to less tax than what otherwise would be the case under a guaranteed investment product.

Another benefit for older annuitants (age 65+) is that life annuity payments not only provide a return of capital and interest earned on that capital, they include a mortality element that reflects the fact that some annuitants will die “early” and cease receiving payments under the life annuity. This “mortality gain” from these early deaths is shared with annuitants in the form of higher payments.

Let’s look at an example to demonstrate the potential benefits of a prescribed annuity over other more conventional savings plans. Dan, age 65, has $250,000 in a guaranteed investment certificate (GIC) earning a 4% rate of return ($10,000). Dan plans to use the interest income (and perhaps dip into some of the capital) to supplement his other retirement income.

Assuming Dan is in a 40% tax bracket, he would retain $6,000 of after-tax interest on an annual basis. Alternatively, he could cash in the GIC and purchase a prescribed life annuity, which includes a 10-year payment guarantee in the event of early death. Based on current annuity rates Dan would receive approximately $16,800 per year, of which only about $4,400 is treated as taxable income. This provides Dan with about $15,000 ($16,800 – (40% of $4,400)) each year on an after-tax basis, considerably higher than the $6,000 after-tax income he would have received from the GIC. The higher income is partly the result of the original capital being returned to him, and partly due to the fact that the amount he has to include in taxable income has been reduced to $4,400 under the annuity from $10,000 under the GIC.

Another important thing to keep in mind is that GIC interest income can never qualify as eligible pension income, and therefore does not qualify for pension splitting with a spouse or the $2,000 pension income credit. However, if the owner of a prescribed annuity is 65 years of age or older, the interest portion of an annuity payment qualifies as pension income. This creates the opportunity to split income with a lower-income spouse, as well as have a spouse who is also age 65 or older gain access to the pension income credit. Plus, lower taxable income can result in greater access to income-tested government benefit programs (such as Old Age Security) that Dan may be eligible to receive.

The tax treatment of a prescribed annuity on death is relatively straight forward. Where a single life annuity is acquired, any income earned in the year of death must be reported in the deceased’s final tax return. If annuity benefits are still payable under a guaranteed term, the designated beneficiary of those benefits will continue to receive the payments and the income portion of such payments will be taxed to that person. It is important to note that unlike a GIC, any remaining value of the annuity payable to a named beneficiary is not part of the deceased’s estate and is therefore not subject to probate fees or taxes. Depending on the terms of the annuity contract, the beneficiary may also be able to commute the remaining payments under the guaranteed term and will be taxed on the income portion of that lump sum benefit.

There is another extremely important consideration in comparing a GIC-type investment to a prescribed life annuity. If Dan continued to own the GIC, upon his death any remaining capital will go to the beneficiaries of his estate. But under a life annuity, on Dan’s death there is nothing left to pass along, unless there is a remaining period of guaranteed payments. If Dan lives to a grand old age, he’ll do much better with the life annuity option. But if he dies too early, his estate might lose out in relation to owning a fixed income investment.

However, if Dan is insurable (or already owns life insurance) it may be possible to protect his estate beneficiaries from any loss arising from his premature death. He can purchase a permanent policy (or repurpose an existing policy) and use the death benefit to replace all or a portion of the original capital upon his death. Review the numbers to determine if the use of insurance will provide a net benefit to the annuitant.

In summary, prescribed annuities (with or without insurance) can be a more attractive proposition in today’s interest rate environment. However, it must be understood that the retiree is giving up control of capital for a guaranteed stream of income. It is therefore important for the annuitant to have access to other liquid funds to deal with unexpected expenses. And it must also be understood that the payment stream under the annuity is fixed and won’t change in the future, which can work to the advantage or disadvantage of the client.

The author would like to thank Lea Koiv for her assistance with this article.


Kevin Wark is managing partner of Integrated Estate Solutions and a tax advisor to CALU. He is the author of several tax/estate planning books entitled The Essential Canadian Guides that are available through and Kindle