Fixed Tax-Deferred Annuity

Fixed Tax-Deferred Annuity

            A fixed tax-deferred annuity, also referred to as a tax-deferred annuity, is a contract between you and an insurance company for a guaranteed interest bearing policy with guaranteed income options.  The insurance company credits interest, and you do not have to pay taxes on the earnings until you make a withdrawal or begin receiving an annuity income.  A person’s annuity contract earns a competitive return that is very safe.  Being tax-deferred means postponing taxes on interest earnings until a future point in time, while the money not being paid in taxes is earning an interest.  This will allow an account to earn more money over a shorter period of time, which will provide a greater income.

            There are a few savings advantages that make this type of annuity tempting to buy.  Many people today are using tax-deferred annuities as the foundation of their overall financial plan instead of CDs or savings accounts.  Although CDs and annuities are similar, there are significant differences between the two.  The most important difference is that annuities allow for the deferral of the taxes due on the interest earned until the interest is withdrawn.  By postponing the tax with a tax deferred annuity, the money in the account compounds faster because it can earn interest on dollars that would have otherwise been used to pay off the IRS.  Later, if someone decides to take a monthly income, the taxes can be less because it will spread out over a period of years.  Like CDs, annuities have a penalty for early surrender, or withdrawal, however most annuity contracts have a liberal “free withdrawal” provision.  While the money is compounding, the owner of the account will not have to pay any taxes.  Someone can also pay a lower tax on random withdrawals because you control the tax year in which the withdrawals are made, and only pay taxes on the interest withdrawn.  Tax deferral gives the owner of the account control over an important expense, the taxes.  Any time someone can control an expense, they can minimize it.  The longer you can postpone this particular expense, the greater your gain when compared to the gain one would make with a fully taxable account.

To illustrate the increased earnings capacity of tax-deferred interest, compare it to fully-taxable earnings. $25,000 at 6.0% will earn $1,500 of interest in a year. A 28% tax bracket means that approximately $420 of those earnings will be lost in taxes, leaving only $1,080 to compound the next year. If these same earnings were tax-deferred, the full $1,500 would be available to earn even more interest. The longer you can postpone taxes, the greater the gain.

Tax-Deferred vs. Fully Taxable

Compare the Return


$107,297 Accumulated in a Tax-Deferred Annuity


$71,966 Accumulated in a Taxable Account


The Difference: $35,331

Note: That at an annuities guaranteed rate of 4%, the return after 25 years would be $66,646.


            Tax deferred annuities are safe.  A qualified legal life insurance company is required to meet its contractual obligations to you.  These reserves must, at all times, be equal to the withdrawal value of your annuity policy.  In addition to the required reserves, state law also requires certain levels of capital and surplus to further increase policyholder protection.  Legal reserve refers to the strict financial requirements that must be met by an insurance company to protect the money paid n by all policyholders.  These reserves must at all times, equal the withdrawal value of every annuity policy.  State insurance laws require that a life insurance company must maintain certain minimum levels capital and surplus, which provide additional policyholder protection.