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Running out of retirement income is a major concern for many Americans. With fewer companies offering traditional pensions with guaranteed payouts, many people must take responsibility for funding their own retirement. Annuities that offer a guaranteed fixed rate of return and tax deferral on earnings, as well as income that can last for life, can be an appealing money management option for present and future retirees with a low-risk tolerance and/or a need to diversify assets.

When you purchase a fixed annuity, you receive a guarantee that your money will earn interest at a specified rate, and your return (the money paid back to you) will occur on a set schedule in fixed amounts. There are two payment options: single premium (one lump-sum payment) or multiple premiums (payments made in installments). Payouts to you can begin immediately, or at a future time, but are usually scheduled for retirement and can last for your lifetime, or another scheduled length of time.

Retirees often favor immediate annuities, which can begin to provide income at regular intervals as soon as a single lump-sum premium has been paid. Deferred annuities, often favored by those saving for retirement, accrue premium payments (your contributions) over time (the accumulation period) with the payout scheduled for a future date. In both cases, earnings on premiums are tax-deferred.

Favorable Tax Treatment

Because annuities help people save for retirement, they receive favorable tax treatment. Tax deferral allows your potential earnings to enjoy compound interest without immediate taxation, which can significantly impact the value of your savings. Consider the following hypothetical example, which assumes earnings at 6%, 30% combined state and federal taxes, and no inflation. Compare the value of saving $100 per month for 30 years in a taxable instrument to a tax-deferred instrument.

Year                Taxable                      Tax Deferred

5                      $6,664                             $6,977

10                    $14,881                           $16,388

15                    $25,016                           $29,082

20                    $37,513                           $46,204

25                    $52,926                           $69,299

30                    $71,934                         $100,452*

*The tax-deferred surrender value would be $81,116, assuming 30% combined state and federal income taxes.

After 30 years, savings in a tax-deferred instrument could be worth $28,518 more than those in a taxable instrument receiving the same rate of return. This attests not only to the power of tax deferral but also the positive effect time can have on your long-term savings.

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Unlike some qualified retirement plans, annuities are not subject to income or contribution limits. Annuity premiums that are not part of a qualified retirement plan are paid with after-tax dollars. Your principal contribution will not be taxed again, but interest earnings are taxable. The Internal Revenue Service (IRS) determines the amount, not taxable using an annuity exclusion ratio, which accounts for your principal contributions and life expectancy, as well as the annuity’s expected return for the life of the contract. The total amount you may exclude from income is limited to the total amount of premium you put into the annuity.

When you reach the point where you have fully recovered your initial premium, the remaining payouts are fully taxable. If payouts cease prior to the date the premium has been recovered, the amount not recovered is allowed as a deduction to you for your last taxable year.

The tax benefits of fixed annuities do come with a restriction: Payouts must begin after you reach age 59½, or earnings may be subject to a 10% federal income tax penalty. Furthermore, if you withdraw funds during the accumulation period, the issuing company may levy withdrawal charges. If you cash in the full value of the annuity, you may incur surrender charges.

Income for Life?

How much you receive from an annuity generally depends on your age when you begin to receive payments and the amount of money available (gender may also play a role), and most annuities have a number of different payout choices. Offering guaranteed income for life and tax benefits, a fixed annuity may be a valuable addition to your long-term retirement plan.

Note: Fixed annuities are neither insured nor guaranteed by the FDIC; they may decline in value if surrendered prior to maturity. Guarantees are based on the claims-paying ability of the issuing company.

Heritage Financial Planning is here to provide guidance, resources, and advice for the betterment of your future. If you have any questions or concerns, give us a call at our office at (574) 606-4406.


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Copyright © 2015 Liberty Publishing, Inc. All rights reserved. Distributed by Financial Media Exchange


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