Tax Deferred Annuity Benefits
A tax-deferred annuity allows individuals to save for their retirement with pre-tax contributions. The contributions to a tax-deferred annuity are usually taken directly from employees' salaries, thereby reducing current taxable income. Investors do not pay taxes on their contributions or their earnings until they funds are withdrawn at retirement.
A tax-deferred annuity is a long-term investment plan in which assets increase over time, and a steady income is ultimately provided. Taxes are imposed on funds only when they are withdrawn, usually upon retirement. Monies taken out of the plans before age 59.5 years are subject to federal income tax penalties and ordinary income taxes.
Tax deferred annuities guarantee the principal and interest rate for a set period of time that is established by an insurance company. There are two main types of tax-deferred annuities: fixed and variable.
Fixed Tax Deferred Annuities
These products provide a guaranteed rate of interest over a specific time period. Earnings increase without being taxed until the income is withdrawn by the annuity's owner, also known as the annuitant. It is important to purchase fixed tax deferred annuities from a stable company that expects to stay in the market for a long time.
Variable Tax Deferred Annuities
This type of tax-deferred annuity offers both choice and flexibility. Monies allocated for variable funding options are subject to the ups and downs of the marketplace, which means that their account balances could be higher or lower than the original value at the time money is actually withdrawn or surrendered.
Variable tax deferred annuities are popular with individuals who want high interest and tax relief on their savings. These products are issued by life insurance companies and represent a good option for those who want safe, predictable investments coupled with a high interest rate and favorable tax treatment.
Features of a Tax Deferred Annuity
One of the major features of tax-deferred annuities is that when yearly interest compounds, it remains tax-free. Other benefits of tax deferred annuities include control over tax payments via the timing of distributions, the option to have a guaranteed income for life, and the provision of a death benefit that can be handed down to beneficiaries, potentially avoiding probate.
While tax deferred annuities are considered to be long-term investments, it is still possible to access the funds in the accounts if necessary. Distributions from the accounts can be made as lump sums or as monthly payments over a lifetime. Insurance companies may impose surrender charges in such cases, however.
Lump sum payments provide the complete value of the annuity contract, but this may be the least attractive option in terms of taxation. Tax liability is incurred for all earnings received in a single year, so a higher tax bracket may result if lump sums are taken.
With the lifetime annuity option, payments are taxed on the basis of the exclusion ratio, with each payment including a partial interest amount (subject to regular income tax) and a tax-free, partial payment of principal until the entire principal is returned.
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