Annuity Tax Guide Canada 2025

Types of Annuities in Canada

Understanding the different types of annuities is essential for choosing the right retirement income strategy. Each type has different features, tax implications, and suitability based on your needs.

Life Annuity

• Payments for your lifetime – income continues no matter how long you live
• No payments to estate – payments stop at death (usually)
• Highest payment amounts – longevity risk is transferred to the insurance company

Term Certain Annuity

• Payments for a fixed period – e.g., 10, 15, or 20 years
• Estate protection – remaining payments go to beneficiaries if you die
• Lower payments – than life annuity because of guaranteed payout period

Joint and Survivor Annuity

• Payments continue to surviving spouse – income for both lifetimes
• Reduced rate options – survivor may receive 50%, 66%, or 100% of original payment
• Lower initial payments – covers two lives instead of one

Guaranteed Period Annuity

• Life annuity with minimum guarantee – combines lifetime income with estate protection
• Example: Life annuity with 10-year guarantee
• Payments to estate – if death occurs before guarantee period ends

Registered vs Non-Registered Annuities

The source of funds used to purchase your annuity determines how it's taxed. This is one of the most important distinctions in annuity taxation.

Registered Annuities (from RRSP/RRIF)

• 100% of payments are taxable – every dollar is included in income
• Same treatment as RRIF withdrawals – no tax advantage vs staying in RRIF
• Purchased with pre-tax money – you got a deduction when contributing
• Qualifies for pension income splitting – at age 65+ (up to 50% to spouse)
• Qualifies for pension income credit – up to $2,000 credit amount

Non-Registered Annuities

• Only interest portion is taxable – capital is returned tax-free
• More tax-efficient – part of each payment is your own money back
• Tax treatment depends on prescribed/non-prescribed status – see below

Prescribed vs Non-Prescribed Annuities

For non-registered annuities, the prescribed vs non-prescribed classification significantly affects when you pay tax.

Prescribed Annuity (Recommended)

• Level taxation each year – same taxable amount throughout
• Interest and capital spread evenly – smooths out tax burden
• Better for early years – defer tax compared to accrual method
• May preserve government benefits – lower taxable income in early years

Non-Prescribed Annuity (Accrual Method)

• Interest taxed as earned – follows economic accrual
• Higher tax in early years – when interest portion is largest
• Lower tax in later years – as capital repayment increases
• Often results in more total tax – due to time value of money

Tax Calculation Example

Let's see how the numbers work with a real example.

Non-Registered Prescribed Annuity Example

If Non-Prescribed (Accrual Method)

• Early years: More interest portion = higher taxable amount
• Later years: Less interest portion = lower taxable amount
• Net effect: Less beneficial due to time value of money

Qualifying for Prescribed Treatment

Not all annuities qualify for prescribed treatment. The annuity must meet specific requirements under the Income Tax Act.

Requirements for Prescribed Status

• Individual annuitant – must be owned by an individual, not a corporation
• Non-commutable – cannot be cashed out or surrendered
• Level payments – payment amounts must be constant
• Life or term certain annuity – must be one of these types
• Annual payments minimum – payments at least once per year

What Disqualifies an Annuity

• Variable payments – indexed or fluctuating amounts
• Cash-out option – ability to surrender for lump sum
• Corporate ownership – owned through a corporation
• Certain guarantee periods – some features may disqualify

RRSP Annuity vs RRIF

When converting your RRSP to retirement income, you have two main options: purchase an annuity or convert to a RRIF. Here's how they compare.

RRSP Annuity Advantages

• Guaranteed income for life – never outlive your money
• No investment decisions – set it and forget it
• Longevity protection – insurance company bears the risk
• Potentially higher income – if interest rates are favorable

RRSP Annuity Disadvantages

• No flexibility – can't change your mind once purchased
• No access to principal – even in emergencies
• No estate value – unless you add a guarantee (at lower payments)
• Locked-in rate – no benefit if rates rise later

Hybrid Approach (Best of Both)

Many retirees benefit from using both options:

• Annuity for base expenses – cover essential costs with guaranteed income
• RRIF for discretionary spending – flexibility for variable needs
• Balance security and control – peace of mind plus adaptability

Tax Reporting

Understanding how to report annuity income on your tax return ensures accurate filing.

Registered Annuity Reporting

• Tax slip: T4A from insurance company
• Report on: Line 11500 (Other pensions and superannuation)
• Pension income credit: Qualifies for up to $2,000 credit

Non-Registered Annuity Reporting

• Tax slip: T5 showing interest portion only
• Report on: Line 12100 (Interest and other investment income)
• Capital portion: Not reported (tax-free return of your money)

Pension Income Splitting

Income splitting can significantly reduce taxes for couples with different income levels.

Registered Annuity (from RRSP) – Can Split

• Age requirement: Must be 65 or older
• Split amount: Up to 50% to spouse
• How to claim: File Form T1032 with both tax returns
• Benefit: Lower combined taxes if spouse is in lower bracket

Non-Registered Annuity – Cannot Split

• Not eligible: Interest portion is investment income, not pension income
• Alternative: Consider spousal RRSP annuity for splitting benefits

Tax-Efficient Annuity Strategies

Strategic use of annuities can optimize both income and taxes in retirement.

Annuity Laddering

• Purchase annuities at different ages – 65, 70, 75, etc.
• Get better rates as you age – shorter life expectancy = higher payments
• Diversify interest rate risk – not all locked in at one rate
• Maintain flexibility – keep options open longer

Cover Basic Expenses Strategy

• Calculate essential costs – housing, food, utilities, healthcare
• Annuity for essentials – guaranteed income covers the basics
• RRIF/TFSA for extras – flexibility for travel, gifts, discretionary spending
• Peace of mind – essentials are always covered regardless of markets

Tax-Efficient Non-Registered Strategy

• Use prescribed annuity – maximize tax deferral
• Lower taxable income in early years – only interest portion is taxed
• May preserve government benefits – keep income below OAS clawback threshold
• GIS preservation – for lower-income seniors, prescribed annuity may help maintain GIS eligibility

Special Situations

Annuity from Pension Plan

• Different rules – not the same as a purchased annuity
• 100% taxable – defined benefit pension payments are fully taxable
• Pension splitting at any age – unlike RRSP annuity, no age 65 requirement

Foreign Annuities

• May be taxed differently – depends on tax treaty with source country
• Foreign tax credit available – claim credit for foreign withholding tax
• Reporting requirements – may need to file foreign income forms

Impaired Life Annuities

• Higher rates for health conditions – underwritten based on medical history
• Shorter expected life = higher payments – can be 10-30% more than standard rates
• Same tax treatment – prescribed/non-prescribed rules still apply

Death and Annuities

What happens to your annuity when you die depends on the type you purchased.

Life Only Annuity

• Payments stop at death – no continuing payments
• Nothing to estate – remaining value stays with insurance company
• No tax consequences – nothing to report on final return

Guaranteed Period Annuity

• Remaining payments to beneficiary – for the rest of guarantee period
• Taxable to recipient – beneficiary reports income on their return
• Lump sum option – commuted value may be available (fully taxable)

Joint and Survivor Annuity

• Payments continue to survivor – at the elected percentage (50-100%)
• Survivor pays tax – reports income on their own return
• No estate involvement – seamless transition