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Life Health > Annuities

Reaping the tax benefits of annuities

By Rich Lane

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Every tax season, Americans file their returns and many are faced with the tough realization of how much money from their investments are lost due to taxes. Based on various investment decisions, it may be worth asking your clients if Uncle Sam is breaking their piggy bank.

When clients allocate their investment funds, it’s important they understand the tax implications. Clients who have money in taxable investments may be losing money every year to taxes, decreasing after-tax return. In some cases, taxes may even outpace investment performance to leave investors with an annual net loss.

Your clients are likely to be familiar with certificates of deposit (CDs) and may have even been or currently are invested in them. The annual income taxes on an investment such as a CD can take a big bite out of your clients’ hard-earned savings. For those who currently hold CDs, it may be time to consider purchasing an annuity, which can offer several ways to access annuity funds without paying tax penalties.

Interest earnings on tax-deferred fixed annuities are not taxed until a client makes withdrawals or starts taking regular distributions. As a result, more of your client’s money continues working for him or her instead of Uncle Sam.

Advantages of tax-deferred annuities

Tax-deferred fixed annuities make your clients’ money work harder by earning interest on the principal investment, interest on the interest, and interest on the tax savings. This triple-compounding process is great because interest is not subject to current income tax in an annuity until it’s withdrawn, so 100 percent of your client’s interest can continue to compound instead of being withdrawn currently for tax payments.

Essentially, taking advantage of tax deferral increases your client’s earning power. For example, if your federal tax bracket is 25 percent, and 2.5 percent is earned on a tax-deferred annuity, your client would need to earn a rate of 3.33 percent in a taxable investment to match the earnings of the annuity.

Annuities vs. CDs

Here are just a few key benefits that you can talk through with your clients when positioning how an annuity could work better than his or her current investment option:

  • Flexible withdrawal options without being assessed a surrender charge when a client may have an unexpected expense or sudden need for cash

  • Tax-deferred compounded growth

  • Lifetime income options that ensure clients will never outlive the payment stream from their annuity

  • Guaranteed survivor benefits, as assets can be transferred to beneficiaries as part of a wealth transfer strategy

  • Probate avoidance

  • Exempt from creditors (most states)

Preparing clients for tax season

Be sure to position a tax-deferred fixed annuity by highlighting compounded growth, a minimum guaranteed return and flexible access to money along the way with an annuity purchase. By doing so, you can save clients from feeling the pain next tax season. 

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