A fixed annuity, also referred to as a tax-deferred annuity, is a contract between you and an insurance company for a guaranteed interest bearing policy with guaranteed income options. Keep in mind taking an income stream from an annuity is ONLY an option, you dont have to do it (read Annuities for Income for details).
Tax-deferred means postponing your taxes on interest earnings until a future point in time. In the meantime you earn interest on the money you're not paying in taxes. You can accumulate more money over a shorter period of time, which can ultimately provide you with a greater income.
Dont be lured with an annuity that has a high first year rate. We ONLY use fixed annuities that guarantee the rate for the length of the annuity (5-years, 7-years, 9-years). Also some annuity companies give you a bonus rate that you can only keep if you keep the money with their company. We wont sell you these annuities either.
Savings Advantages/ Tax Advantages
Many people today are using tax-deferred annuities as the foundation of their overall financial plan instead of certificates of deposit or savings accounts. Although CD's and annuities are very similar, there are significant differences between the two. The most important difference is that annuities allow for the deferral of the taxes due on the interest earned until the interest is withdrawn. By postponing the tax with a tax-deferred annuity, your money compounds faster because you can earn interest on dollars that would have otherwise been paid to the IRS. Later, if you decide to take a monthly income, your taxes could be less because they will be spread out over a period of years. Like CDs, annuities have a penalty for early surrender, however most annuity contracts have a liberal "free withdrawal" provision.
Tax deferral gives you control over an important expense - your taxes. Any time you control an expense, you can minimize it. The longer you can postpone this particular expense, the greater your gain when compared to the gain you would make with a fully taxable account. No 1099 until you say so.
The Tax-Deferred Advantage
To illustrate the increased earnings capacity of tax-deferred interest, compare it to a fully-taxable earnings. $25,000 at 6.0% will earn $1,500 of interest in a year. A 28% tax bracket means that approximately $420 of those earnings will be lost in taxes, leaving only $1,080 to compound the next year. If these same earnings were tax-deferred, the full $1,500 would be available to earn even more interest. The longer you can postpone taxes, the greater the gain.
When Does My Money Mature?
An annuity policy does not "mature" like a bond or certificate of deposit. Both your principal and interest will automatically continue to earn interest until withdrawn. You can let your money continue to grow, make withdrawals, or begin receiving an annuity income at any time.
If a premature death should occur, the accumulating funds within your annuity may be transferred to your named beneficiaries, avoiding the expense, delay, frustration and publicity of the probate process. Like most assets, the annuity is part of your taxable estate. Your heirs can chose to receive a lump sum payment, or a guaranteed monthly income.