How Does a Tax Deferred Annuity Work?

As you’re researching retirement, you’ll likely hear that tax-deferred annuities are an excellent way to secure your savings.

But what exactly is a tax-deferred annuity and how does it work?

A tax-deferred annuity can be a reliable way of growing and protecting your savings while securing a fixed sum for your retirement years. Read on to learn more about the details and how you can take advantage of this savvy retirement tool, then contact us to learn how we can help.

What Is a Tax-Deferred Annuity?

An annuity is a type of retirement account that allows you to complement your employer provided accounts. It is essentially an investment with an insurance company. The investment will earn a return over time and in the future (if desired) will promise to pay you a fixed sum of money for the rest of your life (and possibly the life of your beneficiary).

How much you will receive from your annuity depends on the amount of money in the account, how long it has been invested, and any interest rate applied to the account.

A tax-deferred annuity qualifies as an investment account that includes the features of both a traditional IRA and an annuity. Like a traditional IRA, contributions to a tax-deferred annuity can be made with either pre-tax dollars or after-tax dollars. During the growth period, you will pay no taxes. However, you will pay taxes when you make a withdrawal.

hold in dollar bill with "annuities" text behind it

How Does a Tax-Deferred Annuity Work?

Annuities help generate a regular guaranteed stream of income for retirement. This is perfect for people looking to fund their retirement years with a guaranteed income flow but who prefer not to take on the risk associated with other investments. Annuities are especially beneficial for retirees who have some money set aside but need protection from market fluctuations.

And the best part?

The money in your account also grows tax-deferred, meaning you won’t have to worry about taxes while your money is growing. This is an excellent option for those looking to minimize their tax burden in the future or who need some extra income without dipping into their current assets.

Disadvantages Of a Tax-Deferred Annuity

One major disadvantage to tax-deferred annuities is that a portion of your money may be “locked-up” in the early years of the investment. Depending on the insurance company, you may need to pay a deferred-sales charge (penalty) if to access it in the early years.

In addition, liquidity might also be limited if you began to take income. Once the annuity company has begun to pay you your stream of income, you no longer have access to the principal.

Another possible disadvantage is that, unlike other after-tax investments, your beneficiaries will not receive a step-up in basis at your death and will pay all taxes due on the earnings at their federal rate (not capital gains).

row of piggy banks

Securing Your Retirement Funds

While a tax-deferred annuity may seem like a good idea, there are certain aspects that you should consider before making your decision.

When planning for retirement, rather than taking advice from your friends, relatives, or the latest financial blogger, it’s best to seek the advice of a financial advisor who can take your specific details into account.

As a financial adviser and fiduciary, my advice is not one-size-fits-all and may even change over time along with your needs.

Ready to learn more? Check out my retirement investment e-book to discover more about how you can lock in retirement savings.

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