The Tax-Deferral Advantage of Annuities
When most people think of annuities, they focus on the income guarantees or the ability to create a predictable stream of payments in retirement. But one of the most powerful—and often overlooked—benefits of annuities is tax deferral.
What Tax Deferral Means
Tax deferral allows your money to grow without being reduced by annual taxes on interest, dividends, or capital gains. Unlike taxable brokerage accounts, where you pay taxes each year on investment income, an annuity allows your earnings to compound untouched until you withdraw them.
This deferral can make a meaningful difference over time. The longer your funds remain invested and untaxed, the greater the potential for compound growth. For investors who don’t need immediate access to their funds, this creates an environment for tax-efficient accumulation—particularly valuable for retirement planning.
How It Works
When you purchase an annuity—whether fixed, indexed, registered index-linked (RILA), or variable—your investment grows inside the contract on a tax-deferred basis. You won’t owe taxes each year as your interest or market-linked earnings accumulate. Instead, taxes are deferred until you begin taking withdrawals or start receiving income payments.
When that time comes, the portion of your payout representing earnings is taxed as ordinary income, while your principal (the amount you contributed) is returned to you tax-free.
Why It Matters for Retirement Planning
Tax deferral can help investors in several ways:
Accelerated Growth Potential: Without annual taxes eating into returns, the compounding effect can significantly boost the long-term value of your investment.
Flexible Timing of Income: You control when to take withdrawals, which gives you flexibility to manage your tax bracket during retirement.
Diversification of Tax Treatment: Annuities can complement other retirement accounts—like 401(k)s or IRAs—helping you diversify how and when your income will be taxed later in life.
Comparing Annuities to Other Accounts
While 401(k)s and IRAs also offer tax deferral, annuities do not have annual contribution limits like those plans. This makes them an attractive option for investors who have already maxed out their retirement accounts but still want additional tax-deferred growth.
It’s also worth noting that annuities are funded with after-tax dollars (unless they’re held within a qualified plan). This means only the earnings portion of withdrawals will be taxable—unlike traditional retirement accounts, where the entire distribution is subject to income tax.
Keeping Tax Deferral When You Switch Annuities: The 1035 Exchange
Another important benefit of annuities is the ability to move from one annuity to another without triggering taxes—thanks to Section 1035 of the Internal Revenue Code.
A 1035 exchange allows you to transfer the accumulated value of an existing annuity into a new annuity contract—such as upgrading from a fixed annuity to a RILA or variable annuity—without losing your tax-deferred status.
This can be valuable if your needs or market conditions change, and you want to take advantage of new features such as enhanced income riders, better crediting strategies, or lower fees.
It’s important to carefully review surrender charges, new contract terms, and any potential benefits you may forfeit from the old contract before making an exchange, as these factors can vary widely by product.
When Tax Deferral Makes Sense
Annuities are best suited for investors who:
Have a long-term time horizon
Are already contributing the maximum to their employer plans and IRAs
Want to supplement their retirement income with additional tax-deferred savings
Prefer predictable growth or income streams in retirement
For those who expect to be in a lower tax bracket during retirement, deferring taxes until then can result in meaningful tax savings.
The Bottom Line
Tax deferral is a simple but powerful benefit that can enhance your long-term retirement strategy. By allowing your money to grow uninterrupted—and maintaining that deferral even through a properly executed 1035 exchange—annuities can help you keep more of what you earn and build a stronger foundation for future income.
As with all investment strategies, it’s important to review your goals, liquidity needs, and time horizon before purchasing an annuity. Tax treatment varies based on individual circumstances, and withdrawals prior to age 59½ may be subject to a 10% federal penalty.
Let’s Build a Tax-Efficient Retirement Strategy
At Saxony Advisors, we help clients create retirement income plans that balance growth, income, and tax efficiency. Whether you’re evaluating annuities for income protection or exploring how tax deferral could strengthen your overall strategy, we can help you make an informed decision.
📞 Schedule a call today to explore how an annuity might fit within your personalized retirement plan.
Disclosure: This material is for educational purposes only and should not be considered tax or investment advice. Always consult your financial professional or tax advisor regarding your personal situation.
