Proposed taxation changes to how CRA will tax prescribed annuities are hidden in other changes planned for life insurance products. Currently, insurers are using the 1971 Mortality Table rates. After December 2015, the proposed new regulations will require that insurers use the 2000 Mortality Table rates with its increased life expectancy. The result will be a drastic increase in the percentage of income that will be taxed.
Here’s an example that shows the magnitude of the change. Using the current rates,a 70 year old male investing $100,000 into an annuity would earn $8,000 income per year, with $2000 of that being taxable. Using the new rates, the taxable portion would increase to $3,100, an increase of 55%.
It gets much worse for Canadians age 80 and over who open annuity contracts. Under the current mortality tables, 80 year olds are mathematically considered to be dead, so all of their annuity income is treated as return of capital, with no taxable income. This will change, as death will be assumed to happen at a later age. For example, for an 80 year old man, the taxable portion of $12,653 annuity income increases from $137 to $2,849.
Interestingly, from what we can see so far, it appears that similar changes aren’t being applied to how RRIFs are treated. One can only assume the reason is, that doing so would extend the time from which CRA would have to collect tax.
Because RRIFs are designed to run out after age 85, many Canadians retirees will outlive their RRIF income. This is why life insurance companies a few years ago came up with Guaranteed Minimum Withdrawal Balance products that offered a guaranteed minimum 5% income stream for life. Unfortunately these have been watered down due to the recent perfect storm of low interest rates, people living longer, and the regulators requiring larger reserves so that insurance companies can meet their guaranteed payout commitments.
This increases the challenge for retirees trying to find reasonable sources of guaranteed income. With these legislative changes, investing in unregistered prescribed annuities will be less attractive, while at the same time, some of the benefits of products that provide guarantee lifetime retirement income are lost.
This is not the only change being considered, as there is also legislation on the table to dramatically reduce the amount of tax sheltering allowed within permanent life insurance policies. This is expected to come into effect in January of 2016, which will be discussed in greater detail in another financial article.
Annuities can still be useful as one part of a retirement strategy to provide guaranteed income for life, liquidity, estate preservation and growth potential. And for unregistered funds, they still have some significant tax advantages over GICs.
Take the time to sit down with a qualified insurance broker to see what your options are. While it’s expected that current annuity policies will not be affected by these changes, a review of your retirement income options would likely be time well spent.