Making the Most of Tax Breaks in Retirement

As a tax professional or financial advisor, you have a responsibility to understand the full retirement journey, especially considering the tax advantages that can make the difference between a comfortable retirement and…well, everything falling apart. 

 

As an example, one of the biggest tax advantages that retirees, and therefore professional advisors, need to know include catch-up contributions. As well as in traditional and Roth IRAs, these contributions are available for 401(k) and HSA accounts. Clients may know about catch-up contributions, but they’re generally less aware of fixed indexed annuities and the help they provide in a retirement account. 

 

Introducing Fixed Indexed Annuities 

 

As the name suggests, these accounts are designed to maintain a fixed level of interest over time. For those who want to eliminate risk as they get closer to retirement, this is one of the best ways to go. What’s better than guaranteeing the same interest rate for a set period? You can calculate expected earnings and ensure that retirement savings last until death. 

 

Traditionally, fixed indexed annuities are tied to a reference index, and the classic example is the S&P 500. Since money in this annuity isn’t actually invested in the stock market, there’s no downturn risk; this is protection that becomes valuable in retirement planning. It finds the magical balance between downside protection and growth potential. 

 

However, after reading the title of this article, you’re probably more interested in the tax advantages for your clients. With this in mind, here are three benefits of choosing a fixed indexed annuity (including the tax benefits!): 

 

1. Tax-Deferred Growth 

 

First, as far as savings accounts go, a fixed indexed annuity doesn’t come with many risks. Not only is the growth predictable, but the tax is deferred until the client chooses to withdraw. While IRA and 401(k) assets are exposed directly to the market, the downside protection of a fixed indexed annuity is highly beneficial for clients. 

 

This being said, your client will need to fund their account with non-qualified dollars if they want to enjoy the tax-deferred growth. In other words, the client must have already paid income tax on the money. Consequently, they will need to fund the account with earnings rather than money from another retirement account (or another untaxed source). 

 

This shouldn’t be seen as a problem, though, since the annuity brings lots of benefits, including a death benefit and income for life. 

 

2. No Contribution Limits 

 

Another advantage of choosing a fixed indexed annuity is that clients aren’t restricted in terms of contributions, unlike IRAs and 401(k)s. If clients are closing in on retirement and want to boost their retirement savings one last time, this is a great option. Alternatively, it appeals to the highest earners who have maximized their contributions elsewhere. 

 

3. Only Tax on Interest 

 

Throughout this guide, we’ve mentioned that tax is only paid at the point of withdrawal. But what we haven’t yet mentioned is that clients only pay tax on interest – the amount earned on top. Why? Because they’ve already paid tax on the other amount. By combining a fixed indexed annuity with other retirement accounts, retirees lower their tax requirements while also boosting their retirement savings. 

 

At this point, we wouldn’t be doing our job if we ignored the age rule with regard to withdrawals. Even with a fixed indexed annuity, the IRS will charge a penalty for all those withdrawing before age 59 and ½. When advising clients, make sure that they understand this rule. If they need early access to the funds, you’ll find better options than an annuity. 

 

Summary 

 

In truth, it’s not surprising that fixed indexed annuities have garnered so much attention in recent years. Clients enjoy the tax benefits, they love the growth potential, and the downside protection offers security at a time when it’s needed most. It’s a strong component of a varied portfolio and complements mutual funds, stocks, bonds, 401(k)s, IRAs, and other savings. 

 

As a financial professional, make sure you consider the circumstances of the individual and build a portfolio that suits their needs. A mix of retirement accounts is wise to support growth potential and protect against downside losses. In other words, to enjoy a happy, healthy, and long retirement!