Annuities can help individuals add some security for their financial future with retirement income. Earnings generated from an annuity can be tax-deferred, although many exceptions exist. This is why many believe annuities are given favorable tax treatment.
An annuity provides a steady stream of income over time, making them an attractive option for retirement planning. Annuities are given favorable tax treatment if you have the right guidance. This should be evaluated on a case-by-case basis with a trusted professional, such as a fiduciary. Deferred taxes might not be inherently advantageous to all.
Do I Pay Taxes on My Annuity Withdrawals?
Your annuity can be set up as an immediate annuity or single premium income (SPIA) annuity, so you receive a dollar amount for a set period. This period can be your lifetime, a joint lifetime or a specific time frame. Deferred annuities allow you to make a large or periodic payment to an insurance company in exchange for tax-deferred growth until you choose to withdraw income.
Annuities are given favorable tax treatment with deferred taxes, but this doesn’t mean you won’t have to pay taxes on them. When it comes to annuity income, the tax treatment affects your withdrawals, and the rate depends on whether you made the purchase using pre-tax or after-tax funds.
Purchasing a qualified annuity with pre-tax dollars means you will have to pay taxes on the money you withdraw from it. If you purchase an annuity using after-tax dollars, you will be required to pay taxes on the earnings. With deferred annuity tax treatment, the taxes you pay will be dependent on the taxes at that time, which may not always be a good thing.
What Are the Types of Annuities?
The purpose of an annuity is to create a safe and protected fund for steady payouts. This is not the right situation for taking major risks in search of higher rewards. Annuity tax treatment will depend on what type of annuity you choose.
1. Fixed Annuity or Multi-Year Guaranteed Annuity (MYGA)
A fixed annuity is an annuity contract that gives you a fixed rate of return for the period stated in the contract. With a fixed annuity, you can make a large, one-off payment or multiple payments to an insurance company, which will then guarantee to pay you a guaranteed interest rate for an allocated period of time. Usually, this is 3-5 years.
In the accumulation phase, when you are investing money in an annuity, the fixed annuity's interest rate is guaranteed and usually higher than other popular fixed-income instruments such as savings accounts and certificates of deposit (CDs). Like other annuities, the fixed annuity tax treatment defers taxes until withdrawal.
2. Variable Annuity
A variable annuity enables you to put money into a range of markets like stocks, bonds, and mutual funds. The value of this type of annuity changes depending on the performance of the investment instruments and the returns are not guaranteed.
Variable annuities allow you to make payments to the insurance company, which then invests in the underlying investments chosen by you. The value of your investment increases or decreases depending on how these investments perform.
This means you face the full risks of the market. You could lose money during fluctuations, even though you could have higher rewards at some point.
One of the major downsides of a variable annuity is the cost. They have high fees, which include administrative fees, sales commissions, and fund expenses. If you want to invest directly in the market, it may be better to seek a different investment plan rather than having a variable annuity.
3. Fixed Index Annuity
Fixed index annuities are a hybrid of a fixed and variable annuity, where the returns depend on the performance of a stock market index. These annuities provide greater potential for higher returns than traditional fixed annuities can offer.
Fixed index annuities provide financial security by protecting your principal from market downturns, while at the same time offering potential returns based on the performance of a benchmark index, capped at a predetermined rate. This type of annuity offers a degree of protection from market downturns. Your initial principal amount remains secure, meaning you will not lose money if the market values go down.
Is an Annuity Right for You?
Annuities are given favorable tax treatment with deferred taxes, but to make use of this benefit, you need strong financial planning. An annuity should be set up based on your individual financial situation to get the most out of it. We work with A-rated companies to help our clients get the most out of their annuities.
Call the Pros at Asset Preservation Wealth & Tax
Any comments regarding safe and secure investments and guaranteed income streams refer only to fixed insurance products. They do not refer in any way to securities or investment advisory products. Fixed insurance and annuity product guarantees are subject to the claims paying ability of the issuing company; not guaranteed by any bank or the FDIC.
Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.
The commentary on this blog reflects the personal opinions, viewpoints and analyses of the author, Stewart Willis, providing such comments, and should not be regarded as a description of advisory services provided by Foundations Investment Advisors, LLC (“Foundations”), an SEC registered investment adviser or performance returns of any Foundations client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment, legal or tax advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Personal investment advice can only be rendered after the engagement of Foundations for services, execution of required documentation, including receipt of required disclosures. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Foundations manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Any statistical data or information obtained from or prepared by third party sources that Foundations deems reliable but in no way does Foundations guarantee the accuracy or completeness. Investments in securities involve the risk of loss. Any past performance is no guarantee of future results. Advisory services are only offered to clients or prospective clients where Foundations and its advisors are properly licensed or exempted. For more information, please go to https://adviserinfo.sec.gov and search by our firm name or by our CRD # 175083.
