GICs are typically the investment of choice for retirees who want guaranteed income. However, with interest rates still so low, they just don’t provide much income these days.
One frequently overlooked alternative for improving returns while still guaranteeing your money is something called an ‘insured’ annuity, a combination of a prescribed life annuity and a life insurance policy, which together will produce a guaranteed income stream and protect the value of your estate.
Let’s say you were considering investing $100,000 in GICs from which you’d earn about $3,000 per year. If that income was taxed at roughly 33 per cent, you’d get approximately $2,000 to spend.
By buying a single life annuity with no survivor benefits, a 60 year-old woman could receive an annual income of roughly $6,093 at today’s rates.
Improving Your After-Tax Income
Since only $1,819 of this amount is taxable (a portion of the income stream in the annuity is considered to be a return of capital), the tax on that amount at 33 per cent would be roughly $600 each year, leaving you with approximately $5,493 to spend – considerably more than a GIC might provide.
The actual results will differ from person to person depending on several factors such as age, gender, tax bracket, current interest rates, insurability and form of annuity chosen.
But one thing remains constant: once you’ve purchased the annuity, you can’t change your mind. Your money is spent, not invested. It can’t be cashed in or transferred to someone else as a gift.
Plus, on your death, the income stops and there’s no capital to leave behind – the wrinkle that turns most people away from annuities in the first place.
Where Hedging With Insurance Makes Sense
That’s why you might consider insuring the principal with a life insurance policy matching the amount of the capital used to purchase the annuity. This way, the annuity generates a payment stream that’s used to pay both the life insurance premium and the tax on the annuity.
Here’s how the numbers work. In this instance, the cost of this coverage would be $1,861 each year. You take the $5,493 you’re receiving after taxes, pay your annual insurance premium of $1,861, and are left with $3,652 to spend however you want.
More importantly, as long as you keep paying your life insurance premiums, you’ll be able to leave the tax-free life insurance benefit of $100,000 to your children, free of probate costs, when you die.
There are, of course, several differences between GICs and insured annuities. GICs, for instance, can be liquidated at their maturity date and the capital could be reinvested at what might prove to be a higher interest rate.
Good Health An Important Factor
An insured annuity plan, on the other hand, is more like an ongoing pension in that the capital is no longer accessible and the income level fixed.
Also, you must be in decent health when you go annuity shopping, or else the cost of the exercise when it comes to buying the insurance may become prohibitive.
On the upside, however, the higher your tax bracket the greater the benefit. Being taxed, say, at 46 per cent rather than the more moderate 33 per in this example would improve your after-tax position, for instance.
There’s much more to know but, for someone looking for ways of improving income without piling on too much risk, an insured annuity can be a useful option.