Could a Fixed Annuity Reduce Your Tax Liability?

Fixed annuities can complement your other retirement-income sources, offering a guaranteed stream of income for a specified period of time. They also offer tax benefits.

Essentially, money that you invest in an annuity grows tax deferred. Moreover, annuities offer a key advantage over other tax-deferred retirement vehicles such as 401(k) plans and individual retirement accounts (IRAs), as there is no annual contribution limit. That allows you to save more money for retirement and can be very helpful if you are close to retirement and need to beef up your nest egg. On the downside, though, annuities may have different fees than other tax-deferred retirement vehicles.

Additionally, all the money you invest in an annuity compounds, or builds upon itself – and you still don’t receive a tax bill, which can be a big advantage over taxable investments. In fact, you don’t receive any sort of tax bill until you eventually make withdrawals, at which time some taxes will be owed – but they will likely be less than had you put the money in a taxable investment.

For example, if you make an annuity payment as a lump sum, the income taxes due will be calculated on the difference between the amount you paid into the annuity and its value when you take distributions. In other words, if you invest $100,000 into an annuity that’s worth $250,000, when you retire at age 65 you’ll owe taxes on your gain of $150,000. Those gains are considered ordinary income, not investment gains, which could be beneficial.

Annuity taxation can be extremely complex.

For more information about how to calculate taxes due on annuity payments, you can review IRS Publication 939, General Rule for Pensions and Annuities or speak with your advisor.

The tax and legal information in this article is merely a summary of our understanding and interpretation of some of the current laws and regulations and is not exhaustive. Investors should consult their legal or tax counsel for advice and information concerning their particular circumstances.