Fixed Tax Deferred Annuities
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 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.
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 withdrawal! By postponing the that tax width 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.
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withdrawals are made, and only pay taxes on the interest withdrawn, Tax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 a 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
Note: That at an annuity that guaranteed rate of 4.00%, the return after 25 years would be $66,646.
Compare the Return
$107,297 Accumulated in a Tax-Deferred Annuity
$71,966 Accumulated in a Taxable Account
The Difference: $35,331
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%, mat be payable on any withdrawal of
interest or qualified premium made prior to age 59 1/2.
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.