What is a Tax Deferred Annuity?

The tax deferred annuity is an investment that allows an individual to save money towards retirement. Individuals can purchase an annuity from an insurance company and then receive scheduled payments upon retirement. A tax deferred annuity offers individuals a way to postpone paying taxes on interest that is earned from the annuity. This type of investment can provide an investor with a way to increase retirement savings, but they can be costly at the same time.

One of the major benefits of purchasing a tax deferred annuity is that it allows individuals to put off paying taxes until the money is withdrawn from the annuity. This provides a way for individuals to put away more money for retirement when compared to a traditional savings or investment account. Once interest is earned from the investments in the annuity, the interest can stay in the account and continue to grow.

Once an individual with a tax deferred annuity turns 59 1/2, he or she can start receiving payments from the annuity. At that point, the individual will have to start paying taxes on the money that is received. Taxes will be calculated based on the marginal tax rate of the individual who is receiving the payments.

With this type of investment, individuals will have several options when it comes to earning annuity interest. One option provides the investor with a fixed rate of return for the life of the annuity. Another type of annuity provides investors with the opportunity to choose investments, such as mutual funds, to invest part of the money in. The third type of annuity is linked to a financial index that increases and decreases in value. The value of the annuity will fluctuate based on the movements of the index.

When purchasing a tax deferred annuity, the purchaser will have the option to choose how long the annuity payments will last. One option that the individual has is to make the payments last for a certain number of years. For example, he or she could choose to receive payments for 20 years after starting retirement. Another option that is available with most annuities is to choose payments that will last for the remainder of the individual's life. Some annuities also provide an option that allows the payments to last for the duration of the lives of a husband and wife.

There are some disadvantages to a tax deferred annuity. Any money that is removed from the annuity prior to retirement age is subject to income tax and an additional penalty. Most annuities also require a significant upfront investment, and often come with a number of different fees that must be paid to the insurance company. Annuity payments are subject to regular income tax, which is often much more than capital gains tax due on other types of investments.