Tax Free Annuity Payments

As the old adage goes, there is nothing certain in this world except for death and taxes. This extends even to annuity payments. Unfortunately, there is no such thing as a tax-free annuity payment. However, there is such a thing as a tax-deferred annuity. So while you can’t escape taxes, you can postpone having to pay them.. 

What is a tax-deferred annuity?

Also known as a fixed tax-deferred annuity, a tax-deferred annuity is an exchange between you and an insurance company wherein you deposit an amount (principal) with them and they provide a monthly income to you based on the annuity’s purchase amount, your age, the type and length of the annuity and other factors. In other words, you purchase a guaranteed interest-bearing policy from an insurance company in order to benefit from the policy’s guaranteed income options.

What exactly does “tax-deferred” mean?

“Tax-deferred” simply means that you postpone paying taxes on interest earnings from a fixed annuity until a future point in time. Your return on principal is non-taxable. So until that future point in time, you earn interest on the money you're not paying taxes on. You can accumulate more money over a shorter period of time, which ultimately results in a greater income for you!

What is the advantage of a tax-deferred annuity over similar savings vehicles?

Most often, tax-deferred annuities are compared to bank Certificates of Deposit (CDs). Although they are indeed very similar, there are distinguishing elements that have made tax-deferred annuities a viable alternative as a savings vehicle. The key difference is that annuities allow the deferral of the taxes due on the interest earned! That postponement enables your money to compound faster since you earn interest on money that would have otherwise gone to taxes. Likewise, if you decide to withdraw a monthly income later on, taxes can be reduced as they will be spread out over a long period.
 
Also, most tax-deferred annuity contracts have a “free withdrawal” clause, which means that you can withdraw money early without penalty. However, like bank CDs, tax-deferred annuities impose a penalty charge for early surrender.
Do keep in mind, however, that withdrawals on a tax-deferred annuity before the age of 59 ½ years old are subject to an IRS penalty tax of 10 percent. That’s about it for taxes on a tax-deferred annuity.

How secure is a tax-deferred annuity?

Tax-deferred annuities are bolstered by a number of laws that ensure your investment is safe and secure. A qualified legal reserve life insurance company is obliged by law to fulfill its contracted commitments to you, i.e. the monthly annuity payments that you receive. Legal reserve refers to the stringent financial requirements that must be met by an insurance company to protect the funds paid by all buyers. These reserves must be, at all times, equal to the withdrawal value of your annuity. In addition, state law also requires certain levels of capital and surplus to provide greater protection to holders of life insurance policies and annuities.

When does my investment in a tax-deferred annuity mature?

Another key difference of a tax-deferred annuity is that it does not "mature" like a bond or bank CD. Both your principal investment and interest automatically continue to earn interest until withdrawn or you reach age 100. You can opt to allow your money to grow, make withdrawals, or begin receiving a monthly annuity payout at any time.
 

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