Fixed Income Annuity Provides Tax-Deferred Growth
Feb 9, 2010 insurance banking
Fixed annuities can often cause people a fair amount of stress when they try and determine the tax treatment. And even though this process can seem a bit too much to handle, the underlying concepts are actually quite simplistic. A fixed annuity is a contract with the insurance company in which you make premium payments and they agree to provide you a fixed income for specified number of years.
One of the most beneficial aspects of the fixed income annuity is the fact that you may receive payments out of the annuity for the span of the contract or the lifetime of the annuitant. These life annuities can provide a guaranteed income throughout the whole duration of your retirement.
On the surface, the tax treatment of fixed annuities is rather simple. In is when you dig into the details that the more complicated parts can emerge. Plainly stated, most annuities have tax-deferred growth, and are taxable upon payment distributions.
Tax-deferred growth means that any growth inside of the annuity account is not taxable until it is distributed to the beneficiary. This growth can provide very significant gains to the overall account value.
Every annuity payment is separated into two categories, nontaxable and taxable. To determine the taxable portion of the annuity distribution, you must first calculate the exclusion ratio. The exclusion ratio is calculated by dividing the investment amount in the annuity by the total amount expected to be received through payments. Each prospective distribution is then multiplied by the ratio to determine the taxable portions.
The portion of the contract that is non-taxable is generally the premiums paid, minus the previous non-taxable distributions and minus the value of any period certain or guaranteed features of the particular annuity contract.
Fixed period contracts are typically easier to calculate than life annuity contracts. In life income annuities, the expected payout amount used to calculate the exclusions ratio is based on life expectancy tables from the U.S. Treasury Department.
Despite the various disadvantages that fixed annuity contracts have, this type of insurance product can be a very effective retirement planning tool. The lifetime income and ability to preserve capital for the duration of your retirement is a very appealing feature of the product. Add in the various tax advantages, and the fixed annuity can be a quite useful financial planning tool.
Be sure to check out Brian Atkinson at The Fixed Annuity Guide to learn more financial planning topics. The fixed income annuity can be used in creative and powerful ways.
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