|
Annuities
have two stages: the accumulation phase and the payout phase. During the
accumulation phase, you make purchase payments to the annuity, either
in one lump sum or on an on-going basis.
Depending
on what type of annuity you own, during the accumulation phase, your annuity's
value will grow based on an interest rate set by the insurance company
(fixed annuity), or fluctuate depending on the value of the sub-accounts
(variable annuity).
In
either case, an annuity grows tax-deferred during the accumulation phase.
Tax-deferred
is not the same as "tax-free." Tax-free investments, such as
most municipal bonds, incur no income taxes on gains. Annuities are taxed
on their gains, but only when you choose to withdraw those gains from
the annuity.
Tax-deferral
is a powerful tool, especially over the long haul. Here's just one example:
John
Smith, currently in the 28% tax bracket, inherits $10,000. He places the
$10,000 in a savings account and holds it for ten years. He is taxed at
the end of every year on his gains.
His
accumulation looks like this:
| |
Beginning
|
Interest
|
Taxes
|
Year-End
|
|
Year
1
|
$10,000.00
|
$600.00
|
$168.00
|
$10,432.00
|
|
Year
2
|
$10,432.00
|
$625.92
|
$175.26
|
$10,882.66
|
|
Year
3
|
$10,882.66
|
$652.96
|
$182.83
|
$11,352.79
|
|
Year
4
|
$11.352/79
|
$681.17
|
$190.73
|
$11,843.23
|
|
Year
5
|
$11,843.23
|
$710.59
|
$198.97
|
$12354.86
|
|
Year
6
|
$12,354.86
|
$741.29
|
$207.56
|
$12,888.59
|
|
Year
7
|
$12,888.59
|
$773.32
|
$216.53
|
$13,445.38
|
|
Year
8
|
$13,445.38
|
$806.72
|
$225.88
|
$14,026.22
|
|
Year
9
|
$14,026.22
|
$841.57
|
$235.64
|
$14,632.15
|
|
Year
10
|
$14,632.15
|
$877.93
|
$245.82
|
$15.264.26
|
| |
|
|
|
|
|
Final
|
$15,264.26
|
n/a
|
$0.00
|
$15,264.26
|
John's
sister, Jane, decides to use her $10,000 inheritance to purchase a $10,000
annuity. She is also in the 28% tax bracket, and will hold it for ten
years. She is only taxed when she decides to withdraw her money.
When
compared to John, Jane used the power of tax-deferral to her advantage:
|
|
Beginning
|
Interest
|
Taxes
|
Year-End
|
|
Year
1
|
$10,000.00
|
$600.00
|
$0
|
$10,600.00
|
|
Year
2
|
$10,600.00
|
$636.00
|
$0
|
$11,236.00
|
|
Year
3
|
$11,236.00
|
$674.16
|
$0
|
$11,910.16
|
|
Year
4
|
$11,910.16
|
$714.61
|
$0
|
$12,624.77
|
|
Year
5
|
$12,624.77
|
$757.49
|
$0
|
$13,382.26
|
|
Year
6
|
$13,382.26
|
$802.94
|
$0
|
$14,185.19
|
|
Year
7
|
$14,185.19
|
$851.11
|
$0
|
$15,036.30
|
|
Year
8
|
$15,036.30
|
$902.18
|
$0
|
$15,938.48
|
|
Year
9
|
$15,938.48
|
$956.31
|
$0
|
$16,894.79
|
|
Year
10
|
$16,894.79
|
$1,013.69
|
$0
|
$17,908.48
|
| |
|
|
|
|
|
Final
|
$17,908.48
|
n/a
|
$2,214.37
|
$15,694.10
|
|
The
above is a hypothetical illustrating tax deferral. It does not reflect
the performance of any particular investment.
|
Tax-deferral
provides an added value for Jane of $429.84 if she were to withdraw the entire balance in year 11. After all,
Jane's annuity earned interest on money that John paid every year in taxes.
The
power of tax deferral is clear, particularly if both options are earning
the same rate and held beyond their maturity date. Also keep in mind
that with higher interest rates, higher tax brackets, and longer maturities,
the power of tax-deferral becomes even more apparent.
For example, if Jane does not withdraw the entire balance in year 11 and lets the money continue to grow tax-deferred, the picture becomes even rosier for her! Most importantly... she has complete control over her tax bill.
|
