Annuities offer several attractive benefits including safety, a guaranteed return, and their exclusion from the probate process. Probably the primary reason, though, is that like IRAs, 401(k)s, and other traditional retirement savings programs, annuities grow on a tax-deferred basis – that is, there is no tax due on an annuity’s earnings until they’re actually paid out. The government allows this tax deferral in order to encourage taxpayers to save for retirement. Without an annual reckoning with the taxman, the entire amount of interest an annuity earns remains in the account, letting the miracle of compound interest work its magic faster than with many savings or investment programs, which must pay taxes annually on their earnings.
There’s one big difference between annuities and the other traditional retirement plans, though. While there’s a legal limit on how much you can invest each year in an IRA or a 401(k), there’s no such limit on annuities, which means there’s also no limit on how much tax-deferred interest you can earn.
Tax deferral isn’t just postponing tax payments, though, but usually means reducing the amount of tax due, because taxes are paid at your effective tax rate for the year you receive the payments. If you’re retired when you start receiving the payments, your income – and your tax bracket – are likely lower than they were when the interest was earned.
Although they’re attractive, annuities are best to serve as a retirement savings vehicle because the government imposes a stiff penalty on withdrawals made before you reach age 59½.
For more information on how you can benefit from annuities, please contact us.