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Non-Qualified Annuities & The Tax Gods

Non-Qualified Annuities are still a great way to accumulate money for retirement.  The Tax Gods bestow upon them tax-deferred status during the accumulation phase of your annuity plan and while you can’t deduct your contributions to the plan prior to calculation of your taxes, in time the savings on taxation will help the annuity grow and prosper better than many other types of savings.

Quite simply, a non-qualified annuity is a tax favored account where the interest gained is deferred from taxation during the accumulation phase of your life.  This singular feature enables annuities to significantly impact the rate of return that you can realized over many years.  Let’s look at the interest first.  Let’s say that you can get 5% interest on your non-qualified annuity on a $100,000 balance.  Let’s also assume you are in a 28% tax bracket with Uncle Sam.  In a bank your $100,000 would earn $5,000 over a year on a simple interest basis.  However, at the end of the year your bank is going to send you form 1099-Misc to report the interest to you as income and you will need to report the income to the IRS and pay taxes on the money.  If you’re in a 28% tax bracket you gain is really $3,600 after taxes.  The same annuity would earn $5,000 but would not be subject to taxation until later in your life when your income tax rate is likely much lower.  The effect of the deferral of the tax, without considering the lower future potential tax bracket, is  that your effective interest rate in an non-qualified annuity is more like 6.94% interest during the year.  If you qualify for a lower income tax bracket when you take the money from the account in retirement it is possible that the effective rate of interest is even greater than shown in the latter.

Annuities and non-qualified annuities are basically the same thing.  An IRA Annuity is also the same with the exception that for many of us an IRA is “qualified” by the federal government to be deducted from gross income before our taxes are calculated.  Almost everything else about annuities are the same otherwise.

An annuity is a great mechanism to defer tax on the interest gain on your savings.  In order to get this tax-preference the federal government does establish rules on the time disbursements must begin, they establish a penalty surtax for early withdrawal or surrender, but they also give you certain ways to avoid the sanctions in the laws.  All in all, annuities are a great way to get a great effective rate of interest on your savings and retirement funds.

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