What is a Fixed Tax-Deferred Annuity?
A Fixed Tax-deferred
annuity, also referred to as a tax-deferred annuity, is a contract between
you and an insurance company for a guaranteed interest bearing policy with
guaranteed income options. The insurance company credits interest, and you
don't pay taxes on the earnings until you make a withdrawal or begin
receiving an annuity income. Your annuity contract earns a competitive
return that is very safe.
Tax-Deferred?
Tax-deferred means
postponing your taxes on interest earnings until a future point in time.
In the meantime you earn interest on the money you're not paying in taxes.
You can accumulate more money over a shorter period of time, which
ultimately will provide you with a greater income.
Savings Advantages
Many people today are using
tax-deferred annuities as the foundation of their overall financial plan
instead of certificates of deposit or savings accounts. Although CD's and
Annuities are very similar there are significant differences between the
two. The most important difference is that annuities allow for the
deferral of the taxes due on the interest earned until the interest is
withdrawn! By postponing the tax with a tax-deferred annuity, your
money compounds faster because you can earn interest on dollars that would
have otherwise been paid to the IRS. Later, if you decide to take a
monthly income, your taxes can be less because they will be spread out
over a period of years. Like Certificates of Deposits, annuities have a
penalty for early surrender, however most annuity contracts have a liberal
"free withdrawal" provision.
Tax Advantages
You pay NO taxes while your
money is compounding. You can also pay a lower tax on random withdrawals
because you control the tax year in which the withdrawals are made, and
only pay taxes on the interest withdrawn. Tax deferral gives you control
over an important expense - your taxes. Any time you control an expense,
you can minimize it. The longer you can postpone this particular expense,
the greater your gain when compared to the gain you would make with a
fully taxable account.
The Tax-Deferred Advantage
To illustrate the increased
earnings capacity of tax-deferred interest, compare it to fully-taxable
earnings. $25,000 at 6.0% will earn $1,500 of interest in a year. A 28%
tax bracket means that approximately $420 of those earnings will be lost
in taxes, leaving only $1,080 to compound the next year. If these same
earnings were tax-deferred, the full $1,500 would be available to earn
even more interest. The longer you can postpone taxes, the greater the
gain.
Tax-Deferred vs.
Fully Taxable
Compare the
Return
$107,297 Accumulated
in a Tax-Deferred Annuity
$71,966 Accumulated
in a Taxable Account
The
Difference:$35,331
Safety
Your tax-deferred annuity is
safe. A qualified legal reserve life insurance company is required to meet
its contractual obligations to you. These reserves must, at all times, be
equal to the withdrawal value of your annuity policy. In addition to
reserves, state law also requires certain levels of capital and surplus to
further increase policyholder protection. Legal reserve refers to the
strict financial requirements that must be met by an insurance company to
protect the money paid in by all policyholders. These reserves must be at
all times, equal to the withdrawal value (principal plus interest less
early withdrawal fees, if any) of every annuity policy. State insurance
laws also require that a life insurance company must maintain certain
minimum levels of capital and surplus, which provide additional
policyholder protection.
No More 1099's
There is no withholding tax
while your annuity is compounding; it is completely tax-deferred. If you
request a distribution (random withdrawals or annuity income), taxes will
be withheld - unless you elect differently. Your election not to withdraw
can be made at the time you make your request. Because the interest is
tax-deferred, it is not necessary to issue a From 1099 while your money is
compounding. Only when your interest is distributed (withdrawal or annuity
income) will a Form 1099 be sent, reflecting the amount of interest
actually received.
When Does My Money Mature
An annuity policy does not
"mature" like a bond or certificate of deposit. Both your
principal and interest will automatically continue to earn interest until
withdrawn or you reach age 100. You can let your money continue to grow,
make withdrawals, or begin receiving an annuity income at any time.
What is the Penalty Tax and
When Does it Apply?
An IRS penalty tax, currently 10%, will be payable on any withdrawal of
interest or qualified premium made prior to age 59 1/2.
Avoid Probate
If a premature death should occur, the accumulating funds within your
annuity may be transferred to your named beneficiaries, avoiding the
expense, delay, frustration and publicity of the probate process. Like
most assets, the annuity is part of your taxable estate. Your heirs can
chose to receive a lump sum payment, or a guaranteed monthly income.
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