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If you’re planning for retirement, annuities are likely to be on your mind. But, what is the true definition of an annuity?  And, what are the real benefits? While many contracted annuities are handled through insurance companies, the most basic definition is one that can cover a wide range of payees. When you have an annuity, you pay a certain amount of money to an entity or trust as an investment. When a certain time limit is reached, you receive the cash back.

You may have heard of an annuity as a form of stipend sometimes left behind in a will reading. For instance, an annuity might be $5,000 paid out to a will recipient every month. In the case of retirement planning, however, an annuity is something of a safety net for a retirement strategy. Instead of simply putting money into a bank, this investment strategy can either guarantee a payout at a later date via a fixed annuity, or a payout stream that is determined by the annuity’s underlying investments, otherwise known as a variable annuity.

But here’s the bigger question – when you deal with money, you also deal with taxes, so do annuities give you any sort of advantage come tax season?

The short and simple answer is yes. When you put money into an annuity, the investment is expected to create some kind of growth based on the stipulations of that annuity. With this growth comes tax questions – do I have to spend money to pay taxes on this growth? Annuity growth is actually tax-deferred (like a 401k). However, when you start receiving withdrawals from your annuity, you don’t get taxed on the amount you contributed, you only get taxed on the growth (gains).

This kind of check system is put in place so you don’t get taxed twice for money you invest once. For example, say you pay taxes every year on money you put into an annuity. Once you reach your set retirement age of 65, you withdraw all of your annuity cash as a fixed annuity payout. You’ve suddenly gained a lot of money and then some, but it’s all money that is technically yours and has always been, and the growth is tax-deferred – until you make a withdrawal.

Another way that annuities differ from 401ks and IRAs that can help you with your taxes is that there is no contribution or withdraw limit. While 401k and IRA accounts have maximum investment limits and a requirement to be withdrawn at 70 ½ years of age, you can hold off on your annuity investment for as long as you’d like and contribute as much money as you want.  Therefore, you can defer the taxes as long as you want.

While these are very basic facts for annuities where taxes are concerned, remember to always consult with a tax professional and/or your accountant before investing in an annuity opportunity. Annuities have different stipulations and costs depending on who handles the transactions, so always do your research and ask for the advice of your financial advisor at every step of the process.  Just know that there are tax advantages, and that annuities differ from 401k and IRA accounts.  They are often used to supplement a thorough retirement strategy.

Dan Lucas
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