Are All Annuities Tax Deferred?
Hello, Stan The Annuity Man, America's Annuity Agent. I'm glad you joined me. The question of the day is, are all annuities tax-deferred? Short answer: no. But we need more than that, right? You need more than just the no. You need to know the details of all that. So, hang in there with me, and I'm going to go through all of that in detail so you can fully understand what tax-deferred means, which ones aren't tax-deferred and which ones are, and if annuities make sense for you at all.
Non-IRA and IRA Accounts
So, are all annuities tax-deferred? No. What does tax-deferred mean? Tax-deferred means that you give the annuity company money, and they hold onto it, whether it's a Fixed Annuity, a Multi-Year Guarantee Annuity, a Fixed Indexed Annuity, which is also a kind of a CD type annuity, or Variable Annuity, and they hold onto it. And in a non-IRA account, it grows tax-deferred, meaning that you don't have to pay taxes on that interest every year.
I'll give you an example. If you buy CDs at a bank with just cash in your money market and get interest off that CD, you're paying taxes on the interest. Now, tax-deferred means that you're not paying taxes until you take the money out of the annuity policy in a non-IRA account. IRA accounts obviously are already tax deferred. So that's what that means.
A guy called me the other day, saying, "Hey, I don't want to pay taxes on anything. I paid enough taxes." And I'm like, "Come on, Ernie," I'm going to call him Ernie because I love the name Ernie. I said, "Ernie, you're going to have to pay taxes eventually." But he was told by an agent who was either very young or starving and wanted to sell something that you could tax defer it forever. Eventually, someone will have to pay taxes on that money when you put it in a tax-deferred annuity, like a Fixed Annuity, Indexed Annuity, or Variable Annuity. And by the way, when you take that money out, it's taxed last in first out. I know I'm not a CPA or a tax lawyer, but last in, first out in English means gains first.
So, great example: you have $100,000 and put it in a tax-deferred annuity in a non-IRA account. So, what happens? It grows to $150,000. You start wanting to take the money out of that account. They're going to tax that $50,000 gain first. Last in, first out.
Specific Types of Annuities
Now, let's talk about specific types of annuities. Are they tax-deferred? Single Premium Immediate Annuities are not tax deferred. You can defer it as far out as a year before the income stream starts. But when the income starts, it's a combination of return of principal plus interest. The same could be said for Deferred Income Annuities in a non-IRA account. You can defer it out. There's no growth on that Deferred Income Annuity, but they will pay you an enhanced payout the longer you allow the money to cook at the annuity company.
QLACs are Deferred Income Annuities. They're used in your IRA. So, IRAs are already tax deferred. It really comes down to primarily three types of annuities that are tax deferred. Number one, Multi-Year Guarantee Annuities, Fixed-Rate Annuities. It's the annuity industry's version of a CD. Number two, Fixed Indexed Annuities, which are sold as market products, but they're not. They're life insurance products that return CD-type returns that you need to be aware of. It's not market growth with principal protection, even though everyone sells it as such, but that is also a tax-deferred product.
And then there are Variable Annuities that are tax deferred. In fact, if you want to look at the history of tax deferral in the 1950s, I believe it was 1955, don't quote me on that because I was born in '64, so I wasn't there, but Variable Annuities were put on the planet for tax-deferred growth, period. End of story. In some situations, that works if you're buying the Variable Annuity like a no-load Variable Annuity with all the mutual funds separate accounts inside of it. By the way, the annuity companies call them separate accounts. You and I call them mutual funds because that's, in essence, what they are. But you can have a non-IRA, i.e., non-qualified Variable Annuity, Indexed Annuity, Multi-Year Guarantee Annuity, and that growth is tax-deferred until you take it out of the account.
There Are No Loopholes
Getting back to Ernie, my friend who never wanted to pay taxes. And I think we're all like Ernie. Who wants to pay taxes, right? So, he's thinking, "Hey, is there any way that I can't pay taxes?" Now, there are people selling life insurance products who say you're getting tax-free income. You're not. You're getting a loan from that account. Just believe me that, some people at the IRS are very smart. I know you don't think they're smart, but they're smart. There are no loopholes. You're going to have to pay taxes eventually.
The cool part about annuities, tax-deferred annuities, let's just say, for example, that you bought a Fixed Rate Annuity, a Multi-Year Guarantee Annuity. It was five years in length, so the duration of it was five years. You got a guaranteed percentage for that specific five years. After that, you could take your money and pay the taxes on that interest, right? Last in, first out. Or you can do what's called a 1035 transfer, which is an IRS-approved transfer from one annuity to another annuity without any tax consequences. 1035 is the IRS code, the actual IRS code. If you went to the IRS book and looked for 1035, that's where it's listed. You can actually transfer from one annuity to another, and the cost base is transferred, but you don't have to pay taxes until you take the money out.
So, the question Ernie always said was, "Hey, can I continue to do 1035 transfers till the cows come home..." Southern expression. And I'm like, "Yeah, you actually could. But Ernie, when you die, when your Learjet hits the mountain, when your tractor runs off the road, when your Bentley hits the tree, when your Ferrari explodes, when you're dead, somebody's going to pay taxes on that annuity that's been growing tax deferred."
Thanks for hanging in there with me. I know this blog covered a lot, but I've done a video called How Annuity Income is Taxed that I recommend you watch. If you need quotes, go to our site and use our proprietary annuity calculators; there is no obligation or hassle. We treat you like a professional. You can also get my six annuity owners manuals for free by downloading them with this link. Please subscribe to my YouTube channel because I'm releasing a video daily, Monday through Friday, until my Learjet hits the mountain. Hopefully, that won't happen soon. So, there are lots of videos to come. See you next time.
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