Back-to-Backs are Back!

Dec 12, 2023 | Finance

It can be tough to envision a long, peaceful retirement in moments of market uncertainty, financial stress, and geopolitical conflict. 

When it feels like the world is shaking, it’s no surprise our financial future feels shaky too. Every investor that finds market volatility uncomfortable has had their pulse pounding from the events that have occurred over the past 18 months. This ongoing stress leads many Canadians to reassess the viability of their future retirement plans.

For investors craving the certainty and consistency of a GIC’s returns [1] while wishing to leave an inheritance to their beneficiaries regardless of how long they live, there is another option: a Guaranteed Life Annuity backed by permanent life insurance; or as it’s known in the financial world, a ‘Back-to-Back.’

A life annuity is basically a form of self-made pension, or a guaranteed income for life. If an investor wants to minimize the risk of losing their retirement savings or running out of funds, purchasing an annuity up-front pays out steadily over time, protecting the annuitant from outliving their money. An annuity in a taxable investment account is also far more tax efficient than an investment like a GIC. For example, if David reaches the age of 70 and purchases a life annuity for $250,000, then he can receive $19,004 before tax and $17,500 after tax [2], every year, for his entire life. 

However, the purchase of an annuity demands capital be spent up-front, so it reduces the liquidity of one’s finances. Once purchased, there’s no going back from a life annuity. Does this mean that one’s children or beneficiaries lose out on an inheritance or financial gift? 

This is where the essential component of back-to-backs – life insurance – really kicks in to ‘back’ the annuity. 

Money received from the annuity can then be used to purchase life insurance. So, although the annuity cannot be passed to loved ones, the life insurance can. If it costs $10,000 per year to purchase a life insurance policy worth $250,000, then David can pay the premium with his $17,500 annuity payout and still have $7,500 (net) left over, which he may then spend as he pleases. Note that this is $1,000 more than what David would have received net of taxes from a $250,000 GIC paying out at an average rate of 4% [3] – plus, his annuity payments remain constant for the rest of his life, compared to a GIC that would decline as capital is continuously withdrawn for life expenses [4]. If David’s GIC was used to fund retirement at the same level of spending (i.e. $7,500 per year), then he would eventually run out of funds by about age 88, while his annuity would roll on continuously.

This point should be reinforced: Income available via a life annuity remains constant regardless of how long one lives. This ensures a stable source of income whether one lives to be 75, 85, or 105 years-old. Payments are made like clockwork, no matter what; and your wealth remains protected, transferred to loved ones after the annuitant passes away through life insurance.

This strategy is not without complexity, and there are a number of possible iterations depending on the variables at play, ranging from the relative size of your investment portfolio, to your spending patterns, to your ability to stomach market volatility. A life annuity can play a meaningful role in a retirement plan – especially for those without a pension – by taking the edge off of anxieties derived from market uncertainty. It also creates a consistent and permanent income base over and above the Canada Pension Plan (CPP) and OAS (if applicable).

Through this complexity can come financial security. This is why it is critical to speak to a financial advisor to determine what path is best for you and your family’s future.

As interest rates rise, so do the benefits of a life annuity, once again making them worthy of consideration for those looking to stabilize their future portfolios and reduce worries over financial risk and volatility as they grow older.

Back-to-backs are back, and they are worth a look.


[1] As confidence in the market wanes, alternatives such as GICs become more appealing. GIC rates are at or near their highest levels in over a decade, and many institutions offer 1, 2, or 3 year GICs paying more than 5% interest. But are GICs the best guarantor of future financial safety? If one could live off of only the interest generated by a GIC, then investing in GICs can last you for life. The risk with GICs is that if interest rates go up, you may have already been locked in at a lower rate. If interest rates go down while holding a GIC, your GIC proceeds will be re-invested at a lower rate. Should a sudden expense arise, and if general life expenses and inflation continue to rise in tandem, then a GIC portfolio could eventually run dry if its owner lives longer than expected, leaving little for their loved ones to inherit.

[2] This assumes a 35% marginal tax rate.

[3] $250,000 x 0.04 x (1 – 0.35, i.e. the assumed tax rate).

[4] To implement the back-to-back strategy there is no need to acquire new permanent life insurance if you already have an insurance policy in place.