Annuity providers primarily advertise annuities as a way to secure your income for life. In addition to that, one of the merits of annuities is the various tax advantages associated with them. Typically, the savings on income tax are easily identifiable. However, annuities can also help annuity investors avoid capital gains taxes, and can be part of an estate planning strategy to reduce dreaded estate taxes.
♦ Deferred taxation
Deferred annuities are so called because taxation is deferred until the payout phase begins. The treatment of income from deferred annuities differs according to the tax laws of a specific state or country. In some cases, annuity income from deferred annuities is not taxable. The benefit of deferred taxation is that the accumulated annuity fund is allowed to grow tax-free. This means that you earn interest on what would have been taxed otherwise.
Employer-sponsored deferred annuities are sometimes deducted from your salary before tax, which gives persons additional savings. The only disadvantage there is that the employer claims the tax relief. Another point worth mentioning is that several deferred annuities give the policyholder the option of taking a portion of the accumulated fund tax-free when the annuity matures.
♦ Capital gains reduction
Annuities offer an investment alternative without capital gains tax. Capital gains taxes are lower than income tax. Where income tax is not a factor in annuity payments, annuities tend to be more attractive than taxable investments. Other investment opportunities – such as growth options – might yield higher returns than annuities, but their taxable returns reduce the real return of an investment.
♦ Tax relief on qualified annuities
Annuities that are registered with tax and revenue authorities also provide tax relief as an incentive to save with the annuities. Usually, such annuities are funded by after-tax income. Qualified-annuity investors can benefit from significant tax breaks by reducing their chargeable income by the amount of the annuity contribution.
♦ Estate-tax reduction
Investing in annuities can liquidate estates as an estate planning strategy. This might not seem like a significant benefit until one recognises that many states have estate tax thresholds. If a person purchases a Single Premium Immediate Annuity for $200,000.00, that amount is no longer considered part of the estate. Therefore, the value of the person’s estate decreases by that amount. That also reduces the portion of the estate subject to the dreaded death tax or makes it tax-exempt, depending on the original value. Gift annuities can also be used by senior citizens for this purpose.
♦ Structured settlement annuity account
A structured settlement annuity account also makes an individual exempt from income tax on payments received from it. This is a more complicated use of an annuity for tax purposes, and it sometimes requires the advice of an attorney before you can purchase one. These annuities are utilized in contingent circumstances – like when lumpsum or periodic payments are required immediately.
Apart from helping person combat the risk of outliving their tax savings, annuities have a myriad of tax advantages that make them worthwhile financial instruments.