There are two basic types of deferred annuities, fixed and variable. Image: Fahkamram/Shutterstock.com
By: FEDweek StaffDeferred annuities have become increasingly popular over the years. As the name suggests, these are investment vehicles in which taxes are delayed until money is withdrawn.
Once sold primarily by insurance companies, they’re now offered by banks, brokers, mutual fund families, and other financial institutions as well. Investors pour tens of billions of dollars into these contracts each year.
There are two basic types of deferred annuities, fixed and variable.
Variable annuities allow you to invest in subaccounts that resemble mutual funds. There are few, if any, guarantees but you do have the opportunity to participate in the stock market.
Fixed annuities offer bond-like returns, which appeal less to investors in these times of sagging bond yields and soaring stock prices. With either type, the main advantage of these investments is tax deferral. Inside the annuity contract, investment earnings are untaxed. Ideally, the money will be pulled out after you reach retirement and your tax bracket falls.
Suppose, for example, a married couple was in the 28 percent tax bracket through most of their careers. During this period, they invested in a deferred annuity. In retirement, their taxable income has fallen so they’re in the 15 percent bracket. They take money out of their deferred annuity and pay tax at 15 percent. Not only have they benefitted from tax deferral, they also enjoy tax reduction.
However, many variable annuities impose high fees. On average, variable annuities charge more than 2 percent per year for insurance, administration, and investment management. There usually are surrender charges for the first six or seven years. Fortunately, less-expensive variable funds are available.
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