Deferred Annuities Offer Tax-Deferral and Income Guarantees

I recently read a refreshing, and very honest, article about annuities that I wanted to share with Annuity FYI’s readers.  In Benefits Pro’s “2 biggest arguments in favor of annuities,” John L. Olsen and Michael E. Kitces talk fairly about annuities.  The products are neither good nor bad.  There should not be sides taken and arguments over annuities.  Annuities are tools and should be viewed as such.  For some people they are the right tool to help meet their financial goals, but for others they are not.  So before you join the battle of annuities, whether for or against, try to look at annuities as tools to help you meet your goals.  How well they assist you in meeting your personal goals is the only thing you should use to judge their “right” or “wrong”-ness.  The authors make two strong arguments in favor of annuities, specifically deferred annuities.

The ability to defer taxes is one of main reasons that people buy deferred annuities.  You are able to defer any taxes until you start receiving income payments from your annuity.  In addition to that, you have control over your taxes because you are able to decide when you are going to receive income and how much your payments will be.  Deferred annuities do not have any required minimum distributions.  You are also able to take advantage of compound interest.  Your principal earns interest, your interest earns it as well, and the money you would have paid in taxes with another investment earns interest too.

Keep in mind that these wonderful benefits are not free, although that is not to say that they aren’t worth their costs.  Variable deferred annuities have insurance charges, which include M&E and administrative expenses.  If there are surrender charges with your annuity, you are best suited leaving the money in there until the surrender period has expired.  You also need to pay attention to whether the IRS will penalize you for early distribution before age 59 and a half.  All annuity payments are treated as ordinary income rather than taxed at capital gains rates.  Whether or not this is a disadvantage to you depends on many factors.  It isn’t always a disadvantage.  Another tax deferral benefit that many naysayers don’t take into account is the fact that your benefits extend past the accumulation phase into the distribution phase.  It isn’t until you pass your life expectancy or end a period certain annuity that you lose the tax deferral benefits.

The other main argument in favor of annuities is that they are the only product to guarantee you a certain income amount that cannot be outlived.  While this isn’t true of all annuities, it relates to immediate annuities and deferred annuities that are annuitized.  Most deferred annuities are not.  You simply cannot compare the income received from an annuity to that from another investment because they are not similar.  It’s like the old adage “comparing apples to oranges.”  When income is your only goal, older investors are wise to use some of their assets for an annuity.  Income will be higher and you have managed the risk of outliving your assets.  Those worried about leaving money to heirs are best suited investing some of their other assets elsewhere or adding a death benefit onto an annuity.

Some argue that you should grow your money elsewhere and then purchase an immediate annuity at an older age to receive more income.  That may be best suited to you if your concern is income rather than tax deferral, or both for that matter.  When determining how to manage your risk in retirement planning, the principal guarantees, fixed annuity rate guarantees, and guaranteed living benefits of many variable annuities make annuities worth a look.  Since longevity is continually increasing, it is possible that immediate annuities in the future will not guarantee more income than buying a deferred annuity today.  We have no way of knowing that right now, but buying a deferred annuity mitigates that risk for your future income.  Remember that you will have to pay taxes on an alternative investment when transferring it to an annuity.  Annuities are important to consider not only for the tax deferral you will receive when deferring your payments, but also the tax treatment you will get by taking your money out in payments over time rather than a lump sum.

Two important annuity benefits are tax deferral and the guarantee against outliving your income payments.  If you have any questions about annuities and whether they may be right for you, speak with an expert advisor.  Your individual situation and goals will be the determining factor to whether an annuity is right for you.

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