More about Annuities and Taxes

Most individuals buy annuities to avail the tax-deferred feature and increase their savings at a faster rate. While a variable or an equity-indexed annuity may give higher returns, a fixed annuity is a slow but steady insurance product that promises long-term, tax-deferred savings. It promises a guaranteed minimum rate of return, and offers a safe way to invest your money. But the fun lies in the ability to use your money that you would have parted long back while paying for your taxes. Instead of losing that money, you can use it to reap interests and gain a high rate of growth in your savings. Many understand it wrongly as not being required to pay taxes. Instead, it means you need not pay taxes on your income before you deposit the money, and once you buy the annuity, you can defer your taxes until you start withdrawing money from the annuities. Therefore, if you want to increase your tax-deferred savings, a fixed annuity may prove to be a good option.
To buy an annuity, you can deposit your income for which the tax is not yet paid. This will give you a qualified annuity. The tax-deferred feature is more prevalent on such qualified annuities. A non-qualified annuity means you invest an income for which you have already paid the taxes. These are comparatively easier to establish and when you start withdrawing your gains, you just need to pay the taxes on the interest your annuity earned.
During the accumulation phase of your fixed annuity, the value of the annuity grows at an interest rate promised by the insurance company. For a variable annuity, the interest rate fluctuates in accordance with the market value of the sub-accounts and the value of your annuity changes accordingly. In both cases, the value of the annuity grows along with the tax-deferred features – that is, you need not immediately pay the tax that accrues on the growth of your annuity value. You will need to pay the taxes on this increased value of your annuity when you choose to withdraw the gains. In the long run, it happens so, that as long as you choose not to withdraw your increased savings, you do not pay the taxes. This implies you keep earning interest on your tax amount, and your savings keep growing at a faster rate. Tax-deferral indeed proves to be a powerful tool.
Since it is not that you don’t have to pay taxes on annuity earnings, how, in effect, are your gains taxed? Frankly, the payment of your taxes are deferred or postponed till you start withdrawing the annuity money. As you start withdrawing, your investment gains and the pre-tax income you had invested in the annuity becomes taxable as normal income does. If you withdraw your annuity gains before reaching the age of 59½, you may also need to pay 10 percent of the annuity value as a penalty for withdrawing early. However, if you change annuity schemes instead of withdrawing your gains, you may not need to pay the taxes.

The rules and terms that are offered on the fixed annuities differ from company to company and among annuities. Therefore, it is important to understand the contract document well before you sign it. To learn more about annuities and taxes or to submit questions online, Click here or call AnnuityLibrary.com

Curtis McDowell is a well known author who has been writing on Tax Deferred Annuities for the website www.annuitylibrary.com for a long time.