What is an Annuity and How Does it Work?

From an early age, many Canadians hear the same message about retirement: save early, save often. But as retirement approaches, that focus often shifts. It’s no longer just about the size of your savings — it’s about sustainability. Will my retirement savings last as long as I do?

It’s a real concern. According to an Ipsos poll, nearly one in three (32 per cent) Canadians over age 50 worry they could outlive their retirement savings by at least 10 years. And with Canada’s life expectancy rising, retirement can easily span decades.

Even so, many Canadians lean on familiar savings plans — like RRSPs, TFSAs, RRIFs, and government benefits — to fund retirement. These accounts can be an important piece of the retirement puzzle. But only a small percentage (7 per cent) are tapping into annuities, even though they’re specifically designed to help address one of retirement’s biggest risks: outliving your savings.

If you’re looking to build more certainty in your retirement plan, this guide explains what is an annuity, how it works, the types available, and how it can help support long-term financial security for you and your loved ones.

Key takeaways

• An annuity is a financial contract between you and a life insurance company. In return of a lump sum payment(s), you receive a guaranteed, pre-determined income for a set term or for life.

• A payout annuity converts a portion of your savings into predictable income that isn’t tied to market performance.

• There are three types of annuities in Canada: Single life annuity, Joint life annuity and Term certain annuity.

• The benefits of annuities for Canadians include: guaranteed retirement income, tax benefits, protection from market volatility, and help with estate planning.

• Your annuity income is based on some key factors including : the amount you invest, current interest rate, your age and sex, type of annuity, and payment start date.

What is an annuity?

An annuity is a financial contract between you and a life insurance company. You make a lump sum payment (or a series of payments), and in return, the insurer provides you with a guaranteed, pre-determined income — either for a set period of time (called a term certain annuity) or for the rest of your life (called a lifetime annuity).

Unlike retirement savings accounts that stay invested and require ongoing management, an annuity works differently. Your income is set when you buy it and doesn’t rise or fall with the markets. In exchange, the insurance company assumes the market risk and possibility that you live longer than expected.

Why buy a payout annuity?

Many Canadians heading into retirement worry about outliving their savings — and it’s not an irrational fear. According to Statistics Canada, life expectancy at birth is now 82 years, with women expected to live longer than men (approximately 84 years versus 80 years). Canadians are living longer, and that means retirement may last 20, 25, or even 30 years — and your savings need to keep up.

Government benefits — such as the Canada Pension Plan (CPP), Quebec Pension Plan (QPP), and Old Age Security (OAS) — can provide a helpful foundation of income. But with inflation and the rising cost of living, they may not be enough to fully cover daily living expenses or the lifestyle many retirees have planned.

That means personal savings often need to bridge that gap. Accounts like RRSPs, TFSAs, and RRIFs can grow over time, but their value depends on investment decisions and market conditions. Staying invested in stock markets carries risk since values can rise or fall, while shifting too heavily into cash or low-yield options can cause inflation to quietly erode your purchasing power over time.

A payout annuity takes a different approach. It converts a portion of your savings into predictable income that isn’t tied to market performance. Payments continue according to the terms you chose, helping bring greater stability to your retirement income plan.

How do payout annuities work?

At its core, a payout annuity converts a portion of your savings into predictable retirement income. Setting one up involves a series of decisions:

1. Choose the annuity type

Start by selecting the annuity structure. Do you want payments to last for a fixed period (e.g., 5 years) or for the rest of your life? Should payments continue to a spouse or beneficiary after your death? It all depends on your goals.

2. Select optional features

Some payout annuities offer additional features, such as a minimum payment guarantee period. This means that if the annuitant passes away within a set timeframe, the remaining payments are paid to your beneficiary as a lump sum or as continued payments.

You may also have the option to include indexing features designed to help offset inflation by gradually increasing payments over time.

3. Determine the amount to invest

How much you invest determines the income you receive. The larger the purchase amount, the higher the guaranteed payments will generally be.

4. Choose your funding source

A payout annuity can be funded using money from registered accounts (RRSP, RRIF, DPSP, etc.) or non-registered savings accounts. The tax treatment depends on where the funds come from.

5. Decide how and when to purchase

You can buy an annuity with a single lump sum or through multiple purchases over time. Some people opt to purchase smaller annuities over time (known as “laddering”) to diversify interest rate timing.

6. Select your payment start date and frequency

You can begin receiving payments immediately or defer to a future date. In many cases, deferring payments may result in a higher income, as the funds continue earning interest within the annuity contract before payments start.

Payments are typically made monthly, quarterly, semi-annually, or annually, depending on what best supports your cash flow needs.

7. Work with a professional

A payout annuity is typically just one part of a broader retirement strategy. A licensed insurance advisor can help you evaluate your options, manage tax considerations, and determine how an annuity might align with your long-term goals. Because most annuities are irrevocable once purchased, it’s important to move forward with clarity and confidence.

RBC Insurance offers an online annuity calculator that lets you estimate potential income based on factors such as your sex, purchase age, and contribution amount. You can also compare this to the income you could receive from a RRIF.*

Note: This contribution range for the calculator is between $50,000 and $500,000, but the upper limit is typically $1 million. Contact an RBC Insurance advisor to learn more and get a personalized quote.

Types of annuities in Canada

While annuities can include different features, there are three main types available in Canada:

• Single life annuity: Provides guaranteed income for one person (the annuitant) for life. Payments stop when the person dies, unless a guaranteed period option was selected, in which case remaining payments during that period go to a  beneficiary.

• Joint life annuity: Provides guaranteed income for the lifetime of two people. When the first person dies, payments continue to the surviving annuitant.Payments continue until the second annuitant passes away and may also include a guaranteed period.

• Term certain annuity: Provides guaranteed income for a fixed period (e.g., 10 or 20 years) or until a specified age. If the annuitant dies during the term, payments typically continue to the beneficiary for the remainder of that period.

What are the benefits of annuities for Canadians?

Payout annuities offer several key benefits that can make them a valuable part of a comprehensive retirement strategy. Here’s where they may make a difference.

Guaranteed retirement income

One of the biggest retirement worries? Running out of money. An annuity helps address that longevity risk by providing income that can even continue for as long as you live, depending on the terms you selected. That steady stream can help cover essential expenses, giving you more flexibility and peace of mind with your remaining savings.

Tax benefits

How your annuity income is taxed depends on how it’s funded. If you used money from an RRSP, RRIF, or pension plan, your annuity payments are generally fully taxable as income. That’s because you’re buying the annuity with pre-tax dollars — you received a tax deduction when you contributed, so the income is taxed when it’s withdrawn. In that sense, the tax treatment is similar to drawing income directly from your RRSP or RRIF. However, fixed annuity payments can help make your annual tax obligations more predictable.

If funded with non-registered savings, only a portion of each payment is taxable, since you have already paid tax on this money. In some cases, taxation may be level over time, depending on the structure of the annuity. This can help create greater consistency in your after-tax income.

Another benefit: Depending on your age and circumstances, annuity income may also qualify for the federal pension income tax credit.

Protection from market volatility

Markets move. That’s normal. But in retirement, income stability often matters more than growth. In a market downturn, the value of market-based investments may decline — and retirees may have less time to recover from significant losses.

An annuity’s payments don’t rise or fall with the stock market. Once established, your income continues according to the terms of the contract, which can help reduce uncertainty in your overall plan.

Estate planning

Annuities can help provide continuity of income for the people who matter most. With a joint life annuity, payments can continue to a surviving spouse or partner, helping maintain financial stability after a loss.

If you choose a guaranteed period and name a beneficiary, any remaining payments during that time may go directly to them. In many cases, this can also help avoid probate, which may speed up the transfer and possibly reduce estate-related costs.

For some families, annuities can be a straightforward way to provide ongoing income to children or grandchildren. But the right approach depends on your broader financial plan, so it’s worth discussing with an advisor.

Simplicity

An annuity is set up once, and your income payments are locked in from the start. There’s no need to rebalance a portfolio, pick funds, or keep tabs on the markets.

Unlike many investments that charge ongoing management fees, an annuity’s costs are generally built into the product when you purchase it. That means you’re not dealing with annual portfolio fees year after year.

Because the income amount is set in advance, budgeting can feel more straightforward. For many retirees, that simplicity is part of the appeal.

What determines your annuity payout?

Annuity income isn’t random. It’s based on a few key factors that help determine how long payments are expected to last and how much income can be generated. Here’s what generally feeds into the equation:

• The amount you invest. The more you contribute, the higher your income payments will generally be.

• Current interest rates. Interest rates at the time you purchase the annuity can play a major role. In general, higher interest rates lead to higher payments. Lower interest rates can mean lower payouts.¹

• Your age. Generally, the older you are when you buy an annuity, the higher your payments will be. That’s because payments are expected to be made over a shorter period of time.

• Your sex. Because women statistically live longer than men, payments for women are typically lower for men of the same age and premium.

• Type of annuity. Different annuity structures affect payouts. For example, a term certain annuity that pays income for a fixed period will usually provide higher payments than a lifetime annuity, which is designed to pay for as long as you live.

• The payment start date. If you choose to defer payments, your income may be higher because the funds have more time to earn interest before payouts start.

Invest in your future with payout annuities

Retirement planning often comes down to one basic question: will your income last as long as you do?

Annuities offer one way to turn savings into scheduled income — whether for life or for a set period of time. By providing payments that aren’t tied to market performance, they can add stability to a broader retirement strategy.

Like any financial decision, the right approach depends on your personal goals, tax situation, and existing sources of income. Taking the time to understand your options can help you make more confident choices. If you’re considering whether an annuity might fit into your retirement plan, speaking with a licensed insurance advisor can help you explore the available options and determine what works best for your needs.

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