By Michael Finke


Annuities can be viewed as an account type that changes the tax rules applied to investment growth. Similar to other basis assets such as funds taxed on long-term capital gains, annuities allow an investor to protect annual gains from taxation until the sale or distribution of funds from the account. Unlike long-term capital gain assets, annuity distributions are taxed at ordinary income rates. This makes annuities relatively more attractive for housing investments whose gains are subject to annual taxation on growth, and particularly attractive for investors who expect their marginal income tax rate to decline in retirement.

The increasing availability of low-cost variable annuity wrappers, as well as highly competitive guaranteed returns on fixed multi-year guaranteed annuities (MYGAs)1 and attractive lifetime withdrawal benefits on fixed annuities, provides investors with a range of competitive products that should be considered as alternative to holding bond-like assets in taxable accounts. If the primary goal of non-qualified fixed income investments is to fund less variable spending in retirement, then annuities can provide a higher after-tax return in addition to their unique benefit of protecting against longevity risk.

Since annuities are considered a tax-advantaged retirement saving instrument, early withdrawals are subject to a 10% penalty if withdrawn before age 59.5, and there may be surrender charges that increase the cost of early distributions. Reduced short-term liquidity should be weighed against the potential increase in after- tax spending that can be achieved through the annuity.

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Michael Finke, Ph.D. is a Professor of wealth management and Frank M. Engle Distinguished Chair in Economic Security Research at The American College of Financial Services. He received a doctorate in consumer economics from the Ohio State University in 1998 and in finance from the University of Missouri in 2011. He led the Retirement Planning and Living Consortium at Texas Tech University before moving to the American College, and is a nationally known researcher in the areas of retirement income planning, retirement spending, life satisfaction, and cognitive aging.  He is a frequent speaker at financial planning conferences and was named one of the 25 most influential people in the field of investment advising in 2020 and 2021 by Investment Advisor Magazine.

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