Tax-deferred annuities can be a valuable tool, particularly for retirement savings. However, they are not appropriate for everyone.
Five questions to consider
Think about each of the following questions. If you can answer yes to all of them, an annuity may be a good choice for you.
Are you making the maximum
allowable pretax contribution to employer-sponsored retirement plans (a
401(k) or 403(b) plan through your employer, or a Keogh plan or SEP-IRA if
you are self-employed), or to a deductible traditional IRA? These are
tax-advantaged vehicles that should be fully utilized before you
contribute to an annuity.
Are you making the maximum
allowable contribution to a Roth IRA, Roth 401(k), or Roth 403(b), which
provide additional tax benefits not available in a nonqualified annuity?
Will you need more retirement
income than your current retirement plan(s) will provide? If you begin
making the maximum allowable contributions to both a qualified plan and an
IRA in your 30s or early 40s, you may have enough retirement income
without an annuity.
Are you sure you won't need the
money until at least age 59½? Withdrawals from an annuity made before this
age are usually subject to a 10 percent early withdrawal penalty tax on
earnings levied by the IRS.
Will you take distributions from
your annuity on an ongoing basis throughout your retirement? You typically
have the option of making a lump-sum withdrawal from an annuity, but this
is almost always a bad idea. If you do, you'll have to pay taxes on all of
the earnings that have built up over the years. If you take gradual
distributions, you pay taxes a little at a time, allowing the rest of the
money to continue growing tax deferred. In addition, if the annuity is nonqualified
and you elect to receive an annuity payout, you will enjoy an exclusion
allowance on each payment, in which a portion of each payment is
considered a return of principal and is not taxable.
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