In the early years of the RRSP, annuities were at the heart of every account holder’s retirement discussion.
“When you hit 71, your option was to take it in cash or buy an annuity,” said Adam Chapman, a certified financial planner and founder of London, Ont.-based YESmoney. “It was either a giant tax bill or an annuity, so you were forced to consider those options.”
That all changed in 1978, when then-Finance Minister Jean Chrétien unveiled the Registered Retirement Income Fund (RRIF), opening up a route for retirees to keep their money invested and growing on a tax-deferred basis, while withdrawing whatever they needed beyond the annual legal minimum.
“People just stopped looking at annuities, because there was no forced reason to do so,” Chapman said.
In recent years, annuities have steadily worked their way back into the retirement conversation, thanks in part to a private sector shift that began around the same time as Chrétien’s RRIF announcement.
According to Statistics Canada, around a quarter of paid workers contributed to a defined benefit (DB) pension plan in 2024. That’s down from the DB peak of the 1970s, when close to half of all employees were covered by a workplace plan promising guaranteed pension payments from retirement until death.
With just their Canadian Pension Plan (CPP) and Old Age Security (OAS) benefits to count on in retirement, an increasing proportion of retirees began to consider annuities as an alternative source of guaranteed income, said Rohit Thomas, president and CEO of BMO Insurance.
“Because DB plans have been winding down, a lot of Canadians are now managing their finances well into retirement and annuities are a key component for mitigating that risk,” he said.
There are three main kinds of annuities. Life annuities provide guaranteed income for as long as the client lives. Term-certain annuities provide guaranteed income for a fixed period. Variable annuities provide income that includes a variable component tied to the performance of underlying investments.
Interest rates
Another more obvious factor in the growing popularity of annuities is the current interest rate environment, which links directly to annuity product pricing.
The popularity of annuities dipped in the wake of the 2008 global financial crisis, as the Bank of Canada’s overnight lending rate sat at or below 1% for the bulk of the following decade. And just as interest rate indicators began pointing upward, the Covid-19 pandemic struck, sending the central bank rate right back down — to 0.25% for almost two years.
As rates have climbed back up, there has been greater interest in annuities, according to Paul Savage, Manulife’s Canadian head of individual insurance.
“We’ve seen a spike, really heightening from 2023 and beyond,” he said, adding that there may be room for further growth as the product sheds the stigma built up among advisors and their clients over years of low payout rates.
“If you haven’t looked at annuities in the last few years, I would really suggest taking a look, running some quotes and seeing what’s out there. The value in annuities is significant, and it has increased as rates have,” Savage added.
However, certified financial planner Russell Sawatsky, who owns Money Architect Financial Planning in London, Ont., cautions against placing too much emphasis on interest rates. He recommends focusing on whether an annuity product is a good fit for each specific individual, based on their risk profile, overall health and level of comfort with depleting a potential inheritance.
“If an annuity makes sense for the client, it makes sense regardless of the interest rate environment,” Sawatsky said.
When setting an amount to annuitize, Chapman works with his clients to establish their income requirements in retirement, covering necessities such as housing, groceries, utilities and transportation. Typically, the aim is to have an annuity bridge the gap between a client’s anticipated monthly needs and other sources of guaranteed retirement income, including OAS and CPP benefits, he said.
“You’re annuitizing a very specific amount, but it’s based purely on the cash flow need of the retiree, rather than just a proportion of your portfolio,” Chapman added.
Focusing on income eases the sticker shock many clients feel when they see an annuity pricing chart for the first time, he said.
“They’re quite often the largest financial purchase that any retiree will ever make, next to their home,” he said. “We’re talking about a very big and very important purchase. Those kinds of things tend to make the discussion uncomfortable.”
Chapman encourages his clients to push through the discomfort, explaining that the security provided by an annuity helps clients feel more comfortable with spending in retirement.
“If you’re concerned about your health changing or your spouse passing away, guaranteed income is one of the best ways to maximize those early years,” he said.
Value judgments
Thomas at BMO said another common fear is that the client will pass before they’ve received sufficient value from the annuity.
“The biggest misconception [about annuities] is the lack of flexibility,” he said.
Although the terms of the annuity are irreversible once purchased, there’s plenty of room for customization in advance, he noted.
“Some of this is complicated, and there is an education gap,” Thomas said. “I think it’s a great opportunity for advisors to add value.”
For example, he said retirees can spread the risk by purchasing a joint annuity with a partner, so that payments continue until both policy owners die. Another option is to build in guaranteed payment periods or premium protection clauses that provide for additional payments to the annuitant’s estate or beneficiaries after their death.
Many providers also allow annuitants to inject a form of inflation protection into their product, although the rate applied to annuity payments is typically fixed at the outset, rather than reactive to the consumer price index.
However, each of these additional features comes at a cost, reducing the monthly income that would otherwise be payable to the annuitant in their lifetime.
It’s possible to over-customize, said Moshe Milevski, a professor of finance at York University’s Schulich School of Business.
“The idea only makes sense if you’re truly willing to take the chance,” he said. “If you water down the mortality credit to the point that it’s imperceptible, then you don’t have an annuity anymore. You’ve just bought a very expense bond.”