Like any other investments, annuities too are taxable. The annuity taxation depends upon the type of funds employed in purchasing the annuity and whether it was purchased on a prescribed tax deferred basis. Given below are few different methods that are commonly employed in annuity taxation.

Registered annuities

Annuities that are purchased form sources like pension funds, LRIFs, LIFs, RRIFs, and RRSPs are referred to as registered annuities. In the case of registered annuities, all the income paid out in the calendar year is taxable.

Non- registered annuities

There are two different ways in which non-registered annuities can be taxed. They are as follows:

a) Prescribed

b) Non-prescribed

For annuities purchased with non-registered funds, prescribed taxation can be applicable. Accrual taxation is not applicable to prescribed annuities. This is to say that the interest is taxed as earned rather than expecting interest to be earned over the entire life on a contract that is evenly spread over all payments. Different types of annuities that can be prescribed include Term Certain Annuities, Joint and Survivor Annuities and Single Life Annuities. Prescribed annuities are taxed on a yearly basis. The taxpayer will receive a tax slip for the interest portion of all payments received in that calendar year.

As compared to non-prescribed taxation, prescribed taxation is the better option as the tax is averaged over the lifetime of the annuity. This in turn provides an option of tax deferral. Accelerated annuities are an exception to this as prescribed taxation is based on normal life expectancy. So, in these cases non-prescribed taxation will be more helpful. There are certain conditions that have to be met to qualify for prescribed taxation. Few of them are as follows...

Payments should begin in the current year and not the next

Beyond the 91st year of the owner, payments must not be guaranteed.

The person entitled to receive the payment and the owner must be same

All the payments must be level

Annuity should always be purchased with non-registered funds

However, in the case of non-prescribed method, the annuities are taxed using accrual taxation procedure. The income thus earned will be reported in the taxpayer's income. Taxation in these cases will be on a policy yearly basis wherein the taxpayer will receive a tax lip for the interest portion of the received amount for that year in the consideration.

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