With a deferred annuity, you invest a lump-sum or a series of payments. As long as you keep your money inside the contract, no tax is due on the investment earnings.
Withdrawals generally are taxable, though, and there’s a 10 percent tax penalty if you take money out before age 59 1/2. (Insurers may impose surrender charges, too, for withdrawals in the first few years.) Therefore, a deferred annuity should be a long-term investment, one you don’t expect to tap before age 59 1/2, at the very earliest.
Among deferred annuities, variable annuities offer a menu of investment accounts, including stock funds, bond funds, balanced portfolios, etc. The chief reason to choose a variable annuity is to shoot for higher-than-bond-type returns.
If your stock funds gain ground inside a variable annuity, you won’t owe any tax. You can even switch among accounts without paying tax on gains you lock in. Hopefully, over time you will build up a large account that you can tap to supplement your retirement income.