How Are Annuities Given Favorable Tax Treatment?

It is no secret that annuities enjoy preferential tax treatment. However, many people are not sure why this is the case. This blog post will share with you different types of annuities and how annuities are given favorable tax treatment.

There are several investment tools or plans that you can opt for to secure your family’s future after retirement. An annuity is one of them, which ensures a steady source of income after you retire. 

Moreover, during tax computation, annuities get several benefits like deferred taxes, which allow your retirement savings to grow faster. We will discuss how annuities get favorable tax treatment and all the benefits you can get. 

What Is An Annuity?

How Are Annuities Given Favorable Tax Treatment

An annuity is an insurance contract between you and a financial institution to pay out invested funds in a fixed income stream in the future. You, as an investor, can invest in or buy annuities with a monthly premium payment or a lump-sum payment. An annuity is like a series of payments in regular intervals of time. 

The institution then ensures a stream of payments for a specified period in the future or the rest of the annuitant’s life. They help individuals cope with the risk of outliving their savings after retirement.

Some examples of annuities include monthly home mortgage payments, regular deposits to a savings account, monthly insurance payments, and pension payments. 

Why Do People Opt For Annuity?

For many, it is a form of insurance rather than an investment avenue. When you are no longer working with a regular source of income, you might exhaust your savings at some point. Hence, people invest in annuities way ahead to secure their future post-retirement. 

The process of investing is quite simple if you know what you need and what you are expecting in the end. 

  • Choose an annuity plan and make a lump-sum investment based on your needs and goals.
  • Based on the specifics, you can choose to receive these payments monthly, quarterly, or yearly.
  • Several factors, like the annuity tenure, and others determine the income payout that you will receive.
  • You can choose between a guaranteed payout (fixed annuity) or a performance-backed payout based on the performance of an annuity plan’s underlying investments (variable annuity).

Several banks and financial institutions offer different annuity plans. The minimum age to start an annuity is usually 30 years, while the max limit is not always defined. Some plans have a maximum of 85 years, while others don’t have any limit. 

What Are The Different Types of Annuities?

How Are Annuities Given Favorable Tax Treatment

You can choose from different types of annuities based on your requirements and preferences. 

  1. Deferred Annuity: In this annuity, there is a guaranteed income at a future date, which can be either a lump sum or monthly payouts. There is an interval between the premium payments and annuity payouts.

The tenure for which a subscriber pays the premium is called the accumulation phase, and you pay no tax during this time. 

This is a good option if you want to contribute your retirement income with deferred tax. Then, you don’t have to pay taxes until you take your money out. 

The pros of this type of annuity are that there is protection on the principal protection; no tax growth during the accumulation phase, payment timing flexibility, no annual contribution limits, and no impact by market volatility. But, there can be early-withdrawal penalties if you withdraw before maturity.

  1. Fixed Annuity: Under this plan, the payouts remain constant over the entire tenure. They provide a fixed interest rate on the investment for a designated period. 

The advantages are that you do not have to monitor your investment, you can receive the payouts right away, and you will know exactly how much you will receive at the payout. However, they are not safeguarded against inflation, and the payments can end upon the annuitant’s death.

  1. Immediate Annuity: In this, you have to pay a lump sum as a premium. Then, the payouts start immediately as per the pre-defined payout criteria. These plans guarantee a lifetime income right away with death benefits for beneficiaries. 

This type of plan also brings an opportunity to grow with the market, but it can fluctuate with it as well. Many people don’t prefer it because it is expensive as you have to pay a large sum in one go. 

  1. Variable Annuity: In this, there are variations in the payouts between one instance to the other. The benchmark performance or the index to which the investment is mapped affects the interpretation of these plans. 

They are also subjected to early-withdrawal penalties and market fluctuations. Since it cannot assure specific payouts, many pensioners think it is riskier.

How are Annuities Given Favorable Tax Treatment?

How Are Annuities Given Favorable Tax Treatment

The main part about the tax benefits for annuities is the deferred taxes. There is an option of no tax to be paid during the accumulation period. This helps your investment grow, and only when you take it out is a tax levied on it. So, you must only pay taxes when the contract starts to pay the benefits. 

This also allows you to contribute more than the standard annual amount on a qualified retirement plan such as a 401(k) or IRA.

Often, investors take deferred annuities as short-term investments. But to discourage early withdrawals and loans,  the Internal Revenue Code levies penalties and taxes on them. Additionally, there is a 10% early withdrawal penalty tax on withdrawal from a deferred annuity before the age of 59.5 years. 

If the investor passes away during the accumulation period. The insurer must return either the cash value or the total premiums paid, whichever is greater, to the beneficiary. In this case, a life annuity will pay a specific amount for the rest of the annuitant’s life. 

Reading the annuity plan and contract thoroughly before investing is very important. Ensure that all fees, terms, and conditions are stated boldly and correctly, not in fine print. 

Like a regular life insurance policy, look out for other charges. If mentioned in the plan, such as surrender charges, penalties, administrative fees, etc. Once you are sure, invest in one or more annuity plans. 


If you are looking for retirement savings, annuities are a great option along with the tax benefits you receive during the phase and at the time of payouts. Plan to invest in an annuity today to be assured of good returns later in life, when you are not earning.

I hope you learned from this article How Are Annuities Given Favorable Tax Treatment.

Leave a Comment