If you’re seeking to secure your financial future beyond your working years, you have many options for saving and investing your money. But when it comes to long-term planning, certain investments let you save on a tax-deferred basis.
Combine tax deferral with the long-term growth potential inherent in stock and bond investments and you have an alternative that can help you build the retirement assets you’ll need – a variable annuity.
Variable annuities offer a remarkable combination of tax-advantaged growth opportunities and protection including:
The questions and answers that follow will help you understand more about the valuable role variable annuities can play in your retirement planning.
1Tax-qualified contracts such as IRAs, 401(k)s and others are tax-deferred regardless of whether they are funded with an annuity. However, annuities do provide other features and benefits including, but not limited to, a guaranteed death benefit (based on the claims-paying ability of the issuer) and income choices, for which a mortality and expense risk is charged.
A variable annuity is a contract between you – the annuity owner – and a life insurance company. In return for your purchase payment, the insurance company agrees to provide either a regular stream of income or a lump-sum payout at some future time, generally when you retire.
A variable annuity has an accumulation phase and an income phase. The accumulation phase begins as soon as you invest. Your purchase payment(s) can be invested in the securities portfolios and fixed interest options that are available in your contract. Unlike a mutual fund, where interest, dividends and/or capital gains are taxed each year, any growth in an annuity accumulates on a tax-deferred basis. Of course, your investment can also lose value.
When you are ready to take distributions, typically at retirement, you can choose to have your principal and interest paid out in the form of income payments – called annuitization – or you can take systematic withdrawals or receive a lump sum payout.
For each purchase payment you make, you receive “accumulation units” in the insurance company’s separate account. The separate account purchases shares in professionally managed investment portfolios. The performance of your investment does not depend on the performance of the insurance company’s assets. Only the performance of the investment options you have chosen will affect your results. Each unit’s value or “price” is determined by the value of the investment portfolio, less any insurance charges, divided by the number of units outstanding.
Some annuities now credit investors with payment enhancements on their purchase payments, putting more dollars to work for you up front. Generally, in exchange for the payment enhancement, you’ll accept a higher surrender charge and/or a longer period of time over which the surrender charge applies. These enhancements are generally based on a certain percentage – such as 2%, 3% or 4% of a premium – and are normally added as earnings to the contract. Details of these features are found in each annuity’s prospectus.
Tax deferral can allow the value of your annuity to potentially grow faster than that of a comparable taxable investment. This graph shows the advantages of tax-deferred compounding, assuming a $50,000 investment at an 8% rate of return over 30 years, and a 28% marginal tax bracket.
This chart does not reflect the fees and charges associated with any particular investment. Such expenses would lower overall returns. Although annuities typically include a mortality and expense risk charge of 1.25%, an asset based administration fee of 0.15%, a contingent deferred sales charge which starts at 7% in the first year and decreases 1% each year until it reaches 0%, and an annual contract charge of $30, these charges are not reflected in the hypothetical performance. If they had been reflected, the ending values of the tax-deferred investment would be lower. Gains in the taxable investment may be taxed at a lower capital gains tax rate. Lower maximum tax rates on capital gains and dividends would make the investment return for the taxable investment more favorable, thereby reducing the differences in performance between the accounts shown. You should consult with your tax advisor regarding your particular tax responsibilities and circumstances. This chart is for illustrative purposes only and is not intended to imply or represent a guarantee of any specific return on any particular investment. Please see your financial advisor for performance information of specific investments. Investment results fluctuate and can decrease as well as increase. Withdrawals of taxable amounts are subject to income tax and, if taken prior to age 59 1/2, a 10% federal tax penalty may apply. Early withdrawals may be subject to withdrawal charges. Partial withdrawals may also reduce benefits available under the contract as well as the amount available upon a full surrender.
When you invest in a currently taxable investment, like a mutual fund, any dividends or interest you earn during the year are taxable, even if you reinvest the dividends. Mutual funds can earn money for an investor in several ways, which can be taxed at different rates. Capital gains may be taxed at a capital gains tax rate that is lower than the income tax rate; dividends and interest are generally taxed at income tax rates.
Many investors may not realize that if you sell an investment that has had any gains, or if the mutual fund money manager sells a security that results in a distribution to you, you may owe capital gains taxes.
Variable annuities are insurance alternatives whose gains accumulate tax-deferred and are taxed as ordinary income when withdrawn. When you invest in a variable annuity, any growth is credited to your account but is not taxed until you take distributions, at or near retirement.
In a variable annuity, when you make a withdrawal, you’ll owe income taxes at your then current tax rate on any portion of the withdrawal that is considered earnings. For tax purposes, interest is always considered to be withdrawn first, so unless you begin to exhaust principal, you may owe taxes on the full amount of your withdrawal. In addition, because the IRS set up tax-deferral rules in order to encourage Americans to save for retirement, if you make a withdrawal before age 59 1/2, you’re likely to owe a 10% federal tax penalty on the amount withdrawn.
With an annuity, if the contract owner dies the beneficiary will owe income taxes only on the taxable portion of the death benefit. Special rules apply to spousal beneficiaries, allowing for continuation of the tax-deferred status of the contract in addition to other settlement options.
The beneficiary of a currently taxable investment does not pay income taxes on the earnings received. If you purchase your annuity in a traditional qualified plan such as an IRA or Keogh account, different tax rules apply. Generally, the full amount of any withdrawal, even an amount attributed to principal, is taxable because in a qualified plan the contributions to the annuity are made on a pre-tax basis. Please consult with your tax advisor for additional information.
2 There are many distinctions between mutual funds and variable annuities. For instance, mutual funds serve various short- and long-term financial needs, while variable annuities are designed specifically for long-term retirement savings. Unlike mutual funds, variable annuities include insurance features for which you pay certain fees and charges, including mortality and expense charges and a contract administration fee. Mutual funds and variable annuities each have unique features, benefits and charges, and you should discuss the appropriateness of any investment for your particular situation with your financial advisor.
“Variable” refers to the fact that the contract value and/or income generated by the underlying investment options is not fixed. Your return will vary due to market conditions and prevailing interest rates.
The majority of variable annuities let you choose among portfolios of stocks, bonds and money market alternatives. You can allocate your money among different portfolios, depending upon how aggressive or conservative you wish to be.
You choose the investment options in which you will invest from among those offered in your contract. The insurance company issuing the annuity develops relationships with one or more professional money managers, who decide which specific stocks and bonds will be a part of each investment option. Most variable annuities offer you several different money management firms and multiple investment options within one alternative.
Yes. Most variable annuities provide for withdrawal of a specified amount during the accumulation phase, free of company-imposed charges.
Withdrawals in excess of the amount specified are possible, but may trigger surrender charges. Again, all withdrawals of taxable amounts are subject to income tax, and if you are younger than age 59 ½, the IRS may also impose a 10% federal tax penalty.
You may also encounter a “market value adjustment,” or MVA, if you take money out of fixed-interest options before the end of the interest-rate guarantee period.
The MVA reflects any difference in the interest rate environment between the time you place your money in the fixed account option and the time when you withdraw the money. This adjustment can increase or decrease your contract value.
Finally, be aware that some annuities allow you to make systematic withdrawals from your contract, which can provide you a regularly scheduled income during the accumulation phase. Systematic withdrawals are generally subject to the same tax rules as other withdrawals and must cease upon annuitization.
A contract is “annuitized” when it converts from an accumulation phase to an income phase, and the owner or other payee(s) receive(s) periodic annuity payments. Most companies offer several annuity payment options, based primarily on how long you want the income to last.
The amount of each payment will depend on where your money is allocated – for example, funds in a fixed account will generate a fixed payment; funds in a variable portfolio will generate a variable payment – what annuity option is selected, and your age and gender. Meanwhile, the undistributed portion of your investment can continue to compound, tax-deferred.
Yes. Once you have annuitized, each payment is structured as a partial return of principal and part interest. If you have only contributed after-tax money to the annuity, only the interest portion of the payment is taxable. You should consult your financial advisor and/or tax advisor before deciding to annuitize. See above for a discussion of taxation rules on withdrawals made before you annuitize.
Ask your financial advisor to review your circumstances and determine if an annuity is appropriate for you. Consider the annuity’s unique advantages:
You’ll see why variable annuities can be a valuable alternative in today’s economic and tax environment.
Investors should consider the investment objectives, risks, and charges and expenses of variable annuities carefully before investing. The prospectus contains this and other important information about the variable annuity and its underlying funds. Prospectuses for both the variable annuity contract and the underlying funds are available from your Raymond James financial advisor and should be read carefully before investing.
Variable annuities are long-term investment alternatives designed for retirement purposes. Withdrawals of taxable amounts are subject to income tax, and if taken prior to age 59 ½, a 10% federal tax penalty may apply. Early withdrawals may be subject to withdrawal charges. Partial withdrawals may also reduce benefits available under the contract as well as the amount available upon a full surrender. An investment in the securities underlying variable annuities involves investment risk, including possible loss of principal. Your contract, when redeemed, may be worth more or less than the total amount invested. Past performance is no guarantee of future results.
The purchase of a variable annuity is not required for, and is not a term of, the provision of any banking service or activity. Variable annuities are not federally insured by the Federal Deposit Insurance Corporation (FDIC), Federal Reserve Board or any other government agency and are not a deposit of, guaranteed by, endorsed by, or an obligation of any federal banking institution.
Not FDIC or NCUA/NCUSIF insured • No bank or credit union guarantee • May lose value
Information on this page is provided courtesy of AIG SunAmerica, one of the nation’s largest annuity providers.
For advice concerning the tax treatment of variable annuities and for complete, up-to-date details on tax law, consult a qualified tax advisor. For additional information and the variable annuity prospectus(es) of your choice, please contact your financial advisor or use the convenient Office Locator to find our office(s) nearest you.