Tax Deferral

What is a Tax-Deferred Annuity?

Many retirees wonder how annuities are taxed. First of all, it’s crucial to know that, when an annuity grows in earnings or from potential interest, there are no immediate taxes. But you will have to pay taxes on the income when you eventually withdraw your funds. Any potential interest will be added to your retirement account without incurring taxes at the time of interest payment. Then you pay taxes on any money you withdraw.

The Benefits of a

Tax-Deferred Annuities

So, what is a tax-deferred annuity? It’s a long-term savings contract. Over a period of time, your money can grow, tax-deferred. This means you can contribute money before taxes. You’ll only pay taxes when you withdraw the money. During the time between when you first contribute your funds and when you withdraw them, there’s an opportunity for the funds to grow.

A tax-deferred annuity could also be useful in assisting retirees to get the most out of their other retirement accounts. Your social security benefits, for instance, may decline if your annual income goes up. Any interest from CDs, bonds, or other investments must be reported to the IRS. So you might find that your overall income has grown. This may cause your social security benefits to drop. But if you place your money in as an annuity, those earnings aren’t income right away and don’t count against you. Of course, once you take the money out there’s taxation. But, deferring taxes on your annuity while your money grows can generate great benefits.

After-Tax Dollars and Tax-Deferred Annuities

There are certain benefits you can receive when you purchase a fixed indexed annuity (or FIA) using after-tax dollars. During the accumulation stage of your FIA, it grows tax-deferred, meaning you won’t pay any taxes on your payments until you withdraw money. And when you do withdraw your money, you’ll only need to pay ordinary income tax on your earnings. As time goes on, the tax-deferred annuity growth compounds, and could increase the overall wealth of your annuity. Some retirees find that less immediate tax liability means better long-term retirement income.

Tax-Deferred Annuities Vs 401(K)s and IRAs

401(K)s and IRAs also allow tax deferrals. But delaying taxes through an FIA can have extra benefits that 401(K)s or IRAs don’t. For example, an FIA doesn’t impose a limit on how much money you can put into it. As long as you abide by certain other conditions, you can deposit as much money as you want. While another type of insurance plans such as a 401(K) or IRA might qualify for tax deferral, these products have a maximum contribution limit. This makes FIAs a great choice for retirees who want to save more than what a 401(K) or IRA will allow. Something else to consider is a “rollover” option. It’s possible in many cases to roll over your 401(K) or IRA into a fixed indexed annuity.

Retiring Early Using a Tax-Deferred Annuity

So how are annuities taxed if you retire early? Well, you might receive bonus tax benefits, depending on your situation. But you must meet a few key criteria for these benefits to apply:

  1. You must be under the age of 59 1/2
  2. You must have received a large lump sum payment from your 401(K) profit-sharing plan
  3. This lump sum had to have been part of an early retirement package or severance package.

If the above three statements apply to you, you may have some options. Your money might be able to be rolled over into an annuity policy without being taxed. There are a few methods you could use to obtain this money without being penalized. Now usually, if you want to withdraw funds before you turn 59 1/2, there’ll be a penalty. But if you set a SEPP (substantially equal periodic payments) program, you may be able to get funds from the account. This is a potential tactic to access the money that you thought you couldn’t get until retirement. Deferred annuity taxation can have benefits for retirees.

smiling senior man fishing tax deferred annuities for retirement white bear lake mn

A tax-deferred annuity:

allows you to put off taxes on the money you save until you need it for retirement. Contact our team at Safe Harbor today to see if a tax-deferred annuity could be an option for you.

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