Fixed Deferred Annuity Tax Treatment

With tax reform continuously in the picture, the insurance industry's deferred annuities are quickly becoming a more attractive investment alternative for certain circumstances.


Deferred annuities to serve as an investment alternative

They are especially helpful for those individuals whose incentive to continue to make IRA contributions is greatly weakened by tax rules. Although contributions to a deferred annuity are not tax deductible, earnings do accumulate tax deferred. Advantage over an IRA: There is no limit to the amount of money you can invest in an annuity.


Replacement for investments that received tax benefits

A variable annuity could serve as the ideal replacement for investments that used to receive the benefit of favorable investment tax credits and accelerated write-offs. The reason is that long term gains from investments in stocks, which are currently taxed, can grow tax-deferred in a variable annuity. That income, from gains and dividends, is not taxed until you withdraw your money from the annuity. There are tax implications associated with early withdrawals and surrenders. Withdrawals may be subject to income taxes and, prior to age 59 ½, a 10% federal penalty may apply. Also, a deferred sales charge may be assessed if surrendered during the first years of the contract.

Many variable annuities offer the policy owners a choice of investment accounts with the right to switch funds from one to the other. Thus, funds could be in the growth oriented stock fund during employment years and switch to a more conservative account nearing retirement.

Taxation and Exchange of Older Contracts

If the contract surrendered in the exchange is a pre-TEFRA contract (that is, the contract was issued before August 13, 1982), withdrawals from the contract will be subject to favorable FIFO treatment. The income first rule will not apply. It is not clear, however, how the 10% penalty tax can apply to the contract if withdrawals are not subject to tax. It may be that the penalty will not apply until the investment is withdrawn.

Investors should consider the investment objectives, risks, charges and expenses of variable annuities and their underlying funds carefully before investing. The prospectus contains this and other information and should be read carefully before investing.

Withdrawals or loans will reduce the value of the contract as well as reduce the death benefit. There may be additional costs associated with options or features of a variable annuity that are not typically associated with other investments. Please check the prospectus for details on costs and conditions. The prospectus can be obtained from the financial representative offering the product.

William Bowyer is a self-proclaimed expert in all things financial, and specifically deals with fixed deferred annuity contracts. Visit him online at The Fixed Annuity Guide and learn more about tax treatment of fixed annuities.

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