Tax exemptions are a major benefit associated with contribution to annuities that are qualified’ or registered’. Annuities are medium-to-long term investment products, some of which offer tax deferral on contributions. In the case of tax-deferred annuities, those are primarily designed to provide annuitants with guaranteed lifetime income.
Purchasing a product for a reason other than that which it was designed for is risky business. While tax-treatment of deferred annuities is a well-cited benefit, it should not be the sole reason for purchasing an annuity. Your contributions must not be determined by how much of a tax-break’ you want, but determined in the context of retirement planning. There are several cogent reasons for this.
1) Tax is deferred in the accumulation phase only
Tax-deferred annuities offer tax incentives (up to a certain limit) in the accumulation phase. Payouts from such annuities (after maturity) are subject to tax in accordance with the existing tax structure. This is done to encourage persons to save for retirement. The tax treatment of deferred annuities suggests that it was intended as an additional incentive- not a reason to purchase an annuity.
2) You are also purchasing the demerits of the annuity
Loss of liquidity, loss of fund ownership, low payouts, withdrawal penalties, surrender charges and inflation risk are possible demerits of tax deferred annuities that you tacitly accept when you purchase them. When entering an annuity contract, it is best to assess the merits against the demerits. If your only reason to purchase an annuity is for tax-exemption, then the benefit to you is highly unlikely to outweigh the disadvantages.
3) Tax deferred annuities are designed to provide lifetime income
The main reason for the existence of tax-deferred annuities is to provide a guaranteed lifetime income. These are long-term financial products that should be used to supplement retirement income. Purchasing an annuity for tax exemptions is a short-term decision when a long-term view is required. Apart from this, there are other reasons to purchase annuities- like protection from creditors, guaranteed capital and base interest thresholds- that are higher on the pecking order than tax exemptions.
Purchasing an annuity for the tax treatment solely is a poor financial decision. Unless you can access other benefits, you should reassess the decision to purchase such an annuity on the basis of tax-exempt contributions alone. While you may save on taxes in the short-run, in the long money you will likely lose money in real terms. It is wise to avoid being penny wise and pound foolish, particularly with important financial decisions.