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Equivalent Taxable Return of Fixed Annuities

A comparison of fixed annuity rates and pre-tax rates on a taxable investment

If you have maximized your qualified retirement plan contributions and are looking for a financial product with tax deferral, fixed annuities may be an appropriate choice.

Annuities offer customizable features, allow for higher contributions and may provide lifetime income through annuitization (the process of converting an annuity into a stream of payments). During the accumulation phase, fixed annuity earnings are compounded (meaning both principal and interest earnings are reinvested), potentially allowing those earnings to produce additional earnings in the future. For individuals, annuity earnings are generally tax deferred until withdrawn The following chart shows sample fixed annuity rates and the pre-tax rate equivalent on a taxable investment sorted by current federal income tax bracket

• As the chart illustrates, a fixed annuity with a 5.00% rate of return is equivalent to a taxable ordinary income investment with a 6.67% rate of return for an individual in the 25% federal tax bracket, during each year of the accumulation phase.

• In this instance, the taxable ordinary income investment would have to earn 167% more in taxable interest than the annuity earns, since the annuity grows tax-deferred. Upon withdrawal (usually retirement), taxes due on the annuity may be payable at the annuity owner’s potentially lower federal income tax bracket.