Annuities - Before You Buy

Money Contributed to an Annuity

The money contributed to an annuity may be in post-tax dollars.

When you contribute after-tax savings to an annuity, you can put in as much money as you like. Before you put after-tax savings into an annuity, it may be advisable for you to put the maximum pre-tax amount into a retirement plan such as your IRA, SEP, 401(k) or 403(b). Also note that annuities may fund an IRA, SEP, 401(k), 403(b). When an annuity is used to fund these vehicles there are contribution limits that apply, and federal tax laws generally require that you begin taking minimum distributions by April 1 of the calendar year following the year in which you reach age 70 1/2. Failure to do so will result in a tax penalty of 50% of the amount of the shortfall.

Expenses can vary

Make sure that the annuity contracts you consider have competitive fees. Independent rating services such as Morningstar and Lipper Analytical Services both publish reports that compare variable annuity fees. Your local library may have copies. While cheaper doesn't necessarily mean better, if a contract is too expensive it could offset gains from the tax-deferred status.

Earnings From Annuities

All earnings from annuities are taxed as ordinary income.

If your ordinary income rate at retirement is higher than the current capital gains rate for other investments, you would actually pay higher taxes. You do, however, have a tax deferral on any earnings. With some other investments, you could be subject to ordinary income as well as capital gains taxes annually, even if you have not cashed in the investment, which can reduce the value of your earnings.