A Fixed Annuity Offers More Control over Your Taxes in the US

Investors in higher tax bracket who hold taxable mutual funds may be losing up to 25% of their returns to taxes each year. This loss to taxes can be attributed in part to how portfolio managers control the tax liability that is passed on to shareholders. Whenever fund managers declare a distribution, such as an interest payment or a short-or long-term capital gain, it flows through to the shareholder’s taxable income. These gains are declared and must be reported regardless of whether the shareholder draws money from the fund. This begs the question, if you presently don’t need the income from an investment, why pay taxes on its earnings?

If you invest $100,000 in a bond fund yielding 6%, you could lose up to 20-30% of your return to taxes, leaving you with a 3.5 - 4% return on investment after taxes. On the other hand, a fixed annuity that pays 5% will actually pay 5%, because annuities grow tax-deferred. Therefore all of the interest that is earned in these contracts is reinvested back into the contracts, thus allowing the proceeds to accumulate at a faster rate over time, because the money that would otherwise be paid away in taxes is instead used to earn more interest. They therefore provide the same tax advantage as an IRA or qualified plan, except that there is no limit to the amount of money that can be contributed to an annuity. (Annuity contributions are also nondeductible.)
 
Of course, this doesn’t mean that bond funds are inherently bad investments. But depending on your present and future needs, a fixed annuity can be a viable alternative. The interest rate is locked in for a term that you choose, your principal is guaranteed by the claims paying ability of the issuing company, and you control when to pay income taxes. Annuities are also exempt from the probate process, which means that your heirs will get their inheritance immediately without having to be processed by the courts. They also are generally exempt from creditors; money housed inside annuities is usually safe from lawsuits and other legal garnishments (except divorce.) Fixed annuities can therefore be an attractive investment for conservative investors who have previously looked to CDs and bonds for their income.