A deferred annuity is an agreement with an insurance company to pay the owner a regular income or a lump payment at a later period. Deferred annuities are frequently used to complement other retirement income sources, such as Social Security. Deferred annuities are not the same as immediate annuities, which start paying out immediately.
The three fundamental types of annuities are fixed, indexed and variable deferred. Fixed annuities give a set, guaranteed rate of return on the money in the account. Indexed annuities provide a return based on the success of a market index, such as the S&P 500. The performance of a portfolio of mutual funds, or sub-accounts, chosen by the annuity owner determines the return on variable annuities.
Tax-deferred growth is available with all three types of deferred annuities. Owners of these insurance contracts pay taxes only when they withdraw money from the account, take a lump payment or start receiving income from the annuity. The money they receive is then taxed at their regular income tax rate.
The accumulation phase refers to the period of time when the investor is making payments into the annuity; this is also known as the savings phase. The payout phase, or income phase, begins after the investor elects to start receiving payment. Many deferred annuities are designed to pay out for the duration of the owner’s life, as well as for the life of their spouse.
Which Is Better For You: A CD Or An Annuity?
Fixed deferred annuities and certificates of deposit (CDs) can both be used to build wealth. There are, however, important distinctions between them. Let’s look at two versions of these things that are similar:
- A non-qualified bank CD owned by an individual.
- A non-qualified single-premium deferred fixed annuity owned by an individual.
Examine the following comparisons carefully to determine which of these two products best meets your needs and budget.
Fixed deferred annuities and CDs are both considered low-risk investments. Banks typically issue CDs which are insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 per depositor. The FDIC will guarantee CDs up to this amount if the bank fails.
Insurance firms issue fixed delayed annuities, which are not covered by the US government. They are backed by the issuing insurance company’s ability to pay claims, regardless of the amount.
The amount of time you need to save should be a major consideration when choosing between a CD and a fixed deferred annuity. A CD may be a better option for short-term goals such as a down payment on a home or a new car. The maturation period of a CD might range from one month to several years.
A fixed deferred annuity is meant to help you save for retirement, or to protect the money you’ve already put aside once you’ve retired. When it comes to accessing your money later, a fixed deferred annuity is usually more flexible.
Savings On Taxes
A fixed deferred annuity may be a preferable alternative if taxes are a concern. Interest earned on CDs is taxed in the year it is earned. Earnings build tax-deferred and are not recognized as taxable income until they are withdrawn with fixed deferred annuities. This can be convenient when it’s time to file taxes. The tax deferral may be beneficial if you are saving for the long term, such as for retirement.
Fixed deferred annuities may also help you save money on your Social Security income by lowering or eliminating taxes. If you put your money in a fixed deferred annuity, you may be able to lower your taxable income and maintain it below the amount where you’ll start owing taxes on your Social Security benefits. (In 2020, couples filing jointly with an annual income of less than $32,000 owed no taxes on their Social Security benefits, couples with an income of $32,000 to $44,000 owed taxes on 50% of their Social Security income, and couples with an income of more than $44,000 owed taxes on 85% of their Social Security income.)
Because CD interest is taxable, it will be added to your taxable income for the year. From an annuity, your interest isn’t taxable until you withdraw the money. It won’t count as income that could cause your Social Security benefits to be taxed until you make a withdrawal.
In the event of your death, the account value of your annuity will be distributed directly to your named beneficiaries, eliminating the fees and delays of probate. It is possible that a CD may be subject to probate. Fixed annuities and CDs are both subject to estate taxes if an estate is substantial enough. It is also worth noting that when the earnings from a fixed annuity are paid out, they are subject to income taxes, as opposed to earnings in a CD which are taxed at the time of purchase.
Particular Points To Consider
Because deferred annuities are less liquid than mutual funds acquired outside of an annuity, they should be considered long-term investments.
Most annuity contracts have stringent withdrawal restrictions, such as only permitting one per year. Surrender fees levied by the insurer may apply to withdrawals. In addition, if the account holder is under the age of 59 1/2, the withdrawal will usually be subject to a 10% tax penalty. This is in addition to the income tax due on the withdrawal.
Prospective buyers should be aware that annuities contain significant costs when compared to other types of retirement investments. Fees may also differ significantly from one insurance company to the next, making it a good idea to comparatively shop.
Finally, death benefits are frequently included in delayed annuities. If the owner passes away while the annuity is still accruing value, the heirs may be entitled to a portion or all of the account value. If the annuity has reached the payout phase, the insurer may simply keep the remaining funds unless the contract specifies that benefits are to be paid to the heirs for a set period of time.
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Pillar Life Insurance was created by seasoned entrepreneurs and financial services experts with experience in capital markets and risk management, as well as a solid capital foundation to provide policyholders and stakeholders’ security and stability. If you have any questions or concerns regarding fixed annuities and tax deferment options, contact our helpful staff at Pillar Life Insurance.
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