Annuities are an excellent savings vehicle when you have maxed out the contribution thresholds on your 401k or IRA plan. When this happens, it’s time to talk to your financial advisor. Before we dig into these two types of retirement plans, let’s get clear on the single primary difference between the two. Basically, IRAs are a savings account while an Annuity is an insurance product, which is why the tax implications differ between the two.
An annuity can be an excellent tool for saving for retirement as tax deferred benefits will allow your dollars to grow faster than a comparable taxable investment. One common reason investors choose annuities is that they provide certain advantages that other various IRA investments may not.
First of all, many annuities provide an income stream for life. This is something you won’t find with mutual funds and other investments. Because of this, according to Greg Thompson, CFP, CKA President & Wealth Advisor at Stone Oak Wealth Management, “Annuities are the best option for guaranteed income based on one’s life”. To add contrast to the conversation, Mr. Thompson continues to advise that “Bonds are guaranteed only for a period, but not necessarily for one’s lifetime.”
In addition, many annuities guarantee a death benefit that is no less than the total premiums you have paid into the annuity.
Strengths of Using an Annuity
While considering an annuity for retirement savings, you will need to consider if you will be in a higher, same or lower tax bracket when you receive distributions then while you are actively paying into the Annuity. Many people may be in a lower tax bracket later in life, and the tax savings alone are a great reason to utilize an annuity. However, if your tax bracket could be higher, there are other investment vehicles that will allow you to pay capital gains taxes as gains are realized.
Since most public annuities are not a tax shelter, there are there are no legal limits on how much you can invest in an annuity. However, the law does place limits on contribution amounts for other retirement savings vehicles, such as IRAs. On the flip side, annuities do not have minimum distribution requirements. Other retirement savings vehicles, such as IRAs, require the holder to begin receiving minimum distributions by age 72.
Tax Implications of Using an Annuity
It is important to note that payments into an Annuity are not tax deductible. For this reason, we recommend maxing out your contributions to other available pre-tax retirement plans. In addition, like withdrawals from tax-qualified accounts such as IRAs, annuity withdrawals made prior to age 59½ are typically subject to a 10% early withdrawal penalty, unless an exception applies. If you plan to retire early, or if you think you might need to access your money before age 59½, you should probably explore other options.
When Annuities are a Good Choice
To help you decide whether an annuity is right for you, think about each of these questions, or contact your wealth advisor for clarity in the questions. If you can answer “yes” to all of them, an annuity may be a good choice.
- Are you making the maximum allowable contribution to other pre-tax qualified plans (e.g., a 401(k) or 403(b) through your employer, or a Keogh or SEP-IRA if you are self-employed)?
- Are you making the maximum allowable contribution to an IRA?
- Will you need more retirement income than your current retirement plan(s) will provide?
- Are you sure you won’t need the money until at least age 59½?
- Do you expect to stay in the same tax bracket, or even be shifted to a lower one, when you retire?
- Will you take distributions from your annuity on an ongoing basis throughout your retirement?
The bottom line
Most financial experts agree, and we do too, that you should first fund your deductible IRA and other available retirement plans, such as 401(k)s. When you have to decide how your IRA or 401(k) funds will be invested, choose an investment mix that makes you comfortable. Once you have made the maximum allowable contribution to these plans, then considering an Annuity makes sense. Keep in mind, all investments have risks. Before investing in any retirement vehicle, please talk with your financial advisor regarding the specific pros and cons of these investments to your particular situation.
In the Word
“The way of fools seems right to them, but the wise listen to advice.”
Proverbs 12:15 (NIV)
This warning verse encapsulates the essence of humility. Reminding us that our own perceptions can be clouded by pride, ignorance or arrogance. Fools are often trapped in their own convictions, believing their paths to be correct without considering alternative viewpoints. The wise, on the other hand, exhibit a willingness to acknowledge their limitations and actively seek guidance.
This proverb reminds me of Psalm 23:6 when David praises God as “He leadeth me in the paths of righteousness”. Knowing even he needed #guidance from time to time. David yields himself to inspection so that he can receive wise counsel.
In a world where opinions abound and information is overly accessible, this verse serves as a reminder to approach life with an open, discerning heart and mind. By embracing diverse insights and valuing the #wisdom of others, we can navigate the complexities of life. Ultimately, Proverbs 12:15 encourages us to embrace humility and actively listen, for it is through such openness that we can truly grow in wisdom and understanding.
Sources: Broadridge Investment Management Solutions
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Life insurance products contain fees, such as mortality and expense charges, and may contain restrictions, such as surrender charges. Please keep in mind that the primary reason to purchase a life insurance product is the death benefit. Policy loans and withdrawals may create an adverse tax result in the event of a lapse or policy surrender, and will reduce both the cash value and death benefit.
An annuity is intended to be a long-term, tax deferred retirement vehicle. Earnings are taxable as ordinary income when distributed, and if withdrawn before age 59 1/2, may be subject to a 10% federal tax penalty. If the annuity will fund an IRA or other tax qualified plan, the tax deferral feature offers no additional value. Qualified distributions from a Roth IRA are generally excluded from gross income, but taxes and penalties may apply to non-qualified distributions. Please consult a tax advisor for specific information. There are charges and expenses associated with annuities, such as deferred sales charges for early withdrawals.
Variable annuities have additional expenses such as mortality and expense risk, administrative charges, investment management fees and rider fees. Variable annuities are subject to market fluctuation, investment risk and loss of principal.