Annuities provide a long-term solution for retirement savings. Tax-deferred annuities offer the added benefit of sheltering contribution amounts from taxes. Different types of tax-deferred annuities offer varying rates of return, with no limits on the amount of money a person can contribute to an account. Because of their combined savings and investment features, more than one regulatory agency oversees the sales and management of deferred annuity accounts.
Tax Deferred Annuities
Tax-deferred annuities function much like life insurance policies in terms of insuring account monies against taxation and accumulating earnings over time. Annuities differ in that account holders can receive guaranteed payments from accumulated monies after a certain period of time. Interest earnings come from the investment products insurance companies use to back annuity accounts. Annuity accounts offer higher interest earnings rates than savings accounts, with earnings accumulating on a compound basis. These accounts place no restrictions on the amount of money a person can contribute. And while taxe-deferred annuities offer a profitable investment option, any earnings gains become taxable income once payment distributions begin.
Tax-deferred annuities come in different types that vary in their level of risk, rate of return and income earnings potential. Fixed deferred annuities offer a guaranteed interest earnings rate for a certain period of time, such as one, two or three years. After this period, account earnings match whatever market interest rates prevail from year to year. Fixed annuities provide a consistent rate of return with minimal risk.
Variable deferred annuities function similar to stock options in terms of offering varying rates of return based on the type of investments used. With variable annuities, the account holder selects which types of investments will back his account. Selection options include bonds, mutual funds and money market accounts. As a result, variable annuities carry the highest potential risk and reward.
Index deferred annuities combine features from both fixed and variable annuities. Index annuities guarantee a minimum rate of return while still offering high earnings potential based on market performance. With no limits on contribution amounts, a person can really take advantage of the income earnings potential available through the higher risk annuity products.
Any withdrawals made from a tax deferred annuity account -- whether before or after its maturity date -- become subject to taxes. The taxable amount equals the amount of interest income earned from regular contribution amounts. The rate of taxation corresponds with a person’s income level tax rate; so taxable amounts can vary depending on a person’s tax rate at the time distributions begin.
As a general rule, any withdrawals made before the age of 59 ½ incur a 10 percent federal tax penalty. Tax requirements for tax-deferred annuities can vary depending on how a person sets up her distribution payments once the annuity matures. Once an account matures, account holders can opt to make a simple partial withdrawal, in which case the entire withdrawal amount becomes taxable as interest earnings.
Account holders also can set up a systematic annuity income payment that helps to spread taxable earnings out over the duration of their distribution period. In effect, the unlimited contribution option leaves a person open to large tax costs in cases where an account generates large sums in interest earned.
As with most investment or savings type products, regulatory agencies oversee the marketing, sales and management of tax-deferred annuity accounts. Regulatory agencies help to protect account holders from illegal insurance and investment practices. As tax deferred annuities offer a variety of savings and investment options, different regulatory agencies oversee different types of annuities. Since fixed income annuities function mostly as savings vehicles, state insurance agencies regulate how insurance companies market, sell and manage these types of accounts. As variable interest and index deferred annuities use investment-type products as sources for earnings, the Securities and Exchange Commission oversees these account types because of their connection with the stock market.