What’s the Impact of an Annuity on Your Taxes?

Annuities are tax deferred financial products. If the annuity is purchased with non-qualified money (money that you have already paid taxes on) you are responsible only for taxes on the money's interest earnings, not the principal. In addition, the taxes on the annuity's gains are deferred until you withdraw the earnings. Because you don't pay taxes on earnings every year, the annuity compounds much faster than other taxable savings methods.

If the annuity is qualified, meaning that it was purchased with before-tax dollars (such as money from a traditional IRA or 401k), any amounts withdrawn, including principal, are subject to taxation. In addition, any withdrawals made prior to reaching the age of 59½ are considered a premature distribution and are subject to a 10% tax penalty, on top of the ordinary income tax.

One of the best benefits of annuities are their ability to shelter your earnings from the impact of taxes. Without the continuous drag of taxes, your money grows faster. Faster growth means more money available for you to plan your retirement.

The Power of Triple Compounding:

First, your principal earns interest each year; Second, your credited interest compounds and also earns interest; Third, the money you would have ordinarily paid to the IRS, state or local agencies for taxes remains in your annuity to earn even more interest for you. Over time, the additional interest earnings on these tax savings add up. Depending on your tax bracket, tax deferral can mean 30% - 40% faster growth of your money compared to an ordinary taxable account paying the same interest rate.