Tax time is here. April 15 is the filing deadline. If you’re like most Americans, you’ve probably already filed your tax return. Were you disappointed with the outcome? Perhaps you owed more than you’d expected, or maybe you didn’t get the refund you wanted.
There are many reasons why people face larger-than-expected tax bills. You may have withheld less than needed from your paycheck. Or perhaps you had investment gains that inflated your tax exposure. Perhaps you had a windfall or bonus that pushed you into a higher tax bracket.
As you get closer to retirement, taxes can become a more dangerous risk. Every dollar you pay in taxes is a dollar that can’t be saved for retirement. Once you enter retirement, taxes can reduce your income and limit your ability to live a comfortable and enjoyable lifestyle.
Fortunately, there are steps you can take to minimize your tax exposure. Of course, you need to develop a long-term plan to fully prepare for tax risk. If you wait until filing time to minimize your tax exposure, you may have few options available.
One option to consider as part of your long-term tax strategy is an annuity. Annuities are financial tools that can be used to achieve a wide range of long-term goals. Some annuities provide income that’s guaranteed* for life, no matter how long you live or how the financial markets perform. Other annuities limit your exposure to downside market risk. Some annuities help you achieve multiple goals.
Annuities can also offer tax benefits. Below are a couple of ways in which an annuity could reduce your tax exposure and enhance your retirement strategy:
Some annuities allow you to increase your funds over an extended period of time. These products, known as deferred annuities, offer a variety of growth vehicles. Some pay a set interest rate over a defined period of time. Others allow you to invest directly in the financial markets. And others pay interest linked to the performance of a market index.
No matter how the growth is achieved, one thing is true for all deferred annuities: All growth is tax-deferred inside the contract. That means that as long as the money stays inside the policy, you don’t pay taxes on growth.
You may be familiar with tax deferral from investment vehicles like your 401(k) or IRA. Tax deferral in an annuity works similarly to how it does in those accounts. You don’t pay taxes on growth inside the policy. However, you may face taxes when you decide to take income. Also, you could face an early distribution penalty if you withdraw money before age 59½.
If you’ve already maximized your savings to your 401(k) and IRA, you might consider using an annuity to achieve additional tax-deferred growth. That could reduce your tax exposure on investment growth and allow you to accumulate more assets for retirement.
Another potential annuity benefit is the ability to create guaranteed* lifetime income. There are a couple of ways to do this, but one of the most common approaches is to annuitize a lump sum of money. When you annuitize, the insurance company converts a lump-sum amount into a guaranteed* income stream. That income lasts for life, no matter how long you live or how the financial markets perform.
Annuitized income includes two components. The first is a return of your own premium dollars. The second is accumulated interest. Assuming you used nonqualified dollars to fund the annuity, the return of premium component isn’t taxable. Simply put, a portion of your annuitized income is taxable, and another portion isn’t.
The exact amounts that are and are not taxable vary based on the specifics of your contract. When you choose to annuitize your assets, the insurer will provide an exclusion ratio that tells you what percentage of the income is tax-free.
Annuitized income can help you create lifetime income. However, it can also help you take advantage of tax-free income. Those two benefits could help you enjoy a more predictable and financially stable retirement.
Ready to develop your tax strategy? Let’s talk about it. Contact us today at Thomas Financial. We can help you analyze your needs and implement a plan. Let’s connect soon and start the conversation.
*Guarantees, including optional benefits, are backed by the claims-paying ability of the issuer, and may contain limitations, including surrender charges, which may affect policy values.
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