A Back to Back Annuity can make sense if you are in good health and between 65 and 85 years of age.
Suppose you want a guaranteed higher income but you’re not comfortable with writing a big cheque to an insurance company; you don’t know whether you’ll live long enough to get your money back.
A way around this problem is to buy insurance to protect your annuity investment. This is the reason for the name – you are buying a prescribed annuity and an insurance policy ‘back to back’.
A prescribed annuity generally provides a higher income than other annuities because of the way they are taxed. The income comprises capital return and interest earned. The interest is the portion that is taxable. It is spread over the lifetime of the annuity and so it is lower.
Suppose you are a 65 year old non-smoking male. You have $100,000 in non-registered funds. If you invest this in a GIC paying 4%, you will have an income of $4,000. You pay the government 30% of that in taxes for a net income of $2,800.
Now, if you buy an annuity with your $100,000, you can expect to receive $7,135 in income with a taxable portion of $1,641. Tax is 30% of $1,641 or $492 which leaves you $6,643 to spend.
Not so quick - you have to pay for the insurance. Let’s say that you bought term insurance and the policy costs you $3,025 per year. This leaves you with $6,643 - $3,025 = $3,618 to spend which is higher than the GIC.
Of course, with a GIC you can change your mind the next year and use your $100,000 for some other purpose but with an annuity product you are fully committed and locked in. You will never see the $100,000 again but your estate will.
So why isn’t everyone buying a Back to Back Annuity? Well, there are several factors to consider.
For an annuity to qualify as a prescribed annuity it must be non-registered, guarantee of payments may not exceed the annuitant’s 91st birthday, payments must start no later than 31 December of the year after purchase and payments cannot be indexed.
If the income from this annuity provides you with a major portion of your total income, the fact that this income will not increase over the years, may have a big impact on your lifestyle in later years.
If you are interested in buying a Back to Back Annuity, the first step is to ensure that you are healthy enough to get an insurance policy. Do not buy the annuity until the insurance policy has been issued.
Always deal with someone who will broker these products for you. This way you know that you will have the annuity that provides you with the highest payout and the insurance policy that charges the least premiums.