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Advantages and disadvantages of tax-deferred fixed annuities

  • Fixed annuity contracts offer compound growth without anxiety about fluctuations in the stock market
  • Income taxes are deferred
  • Interest rates are generally competitive
  • Proceeds paid to a named beneficiary are exempt from probate
  • Proceeds may also be exempt from state inheritance taxes
  • You may have the right to take 10 percent (or more) of the account value annually without paying surrender charges (but you are subject to the IRS penalty on withdrawals made before age 59½)
  • If the owner has a medical need for long-term care in a nursing home, tax-deferred earnings may be withdrawn, subject to state laws
  • Switching to another company can be done without incurring any income tax liability (see Section 1035 of the Internal Revenue Code)
  • Values may be transferred from a life insurance contract to a tax-deferred annuity through a Section 1035 exchange
  • You may turn the accumulated account value into a stream of income that you cannot outlive, though the amount you receive may be higher using other payout options
  • You may take withdrawals at some future date when your personal income tax bracket may be lower than it is during your peak earning years (subject to penalty and surrender charges)
  • Depending on your state, account values may be protected from creditors
  • The tax-deferred growth will ultimately be taxed, perhaps to a beneficiary in a higher income tax bracket
  • There is no step-up in basis at death, and capital gains tax rates are not applicable, so all income is taxed as ordinary income
  • Due to possible surrender charges and IRS tax penalties for early withdrawal, the annuity is not considered a liquid asset
  • Ownership by a corporation or any other "non-person" subjects the growth to annual income taxes
  • Some surrender charges may last for many years
  • Some contracts offer a higher rate of interest if you annuitize and a lower rate if you surrender the contract
  • In some states, state premium taxes may reduce the amount of value available for future payments
  • Annuities are not federally insured