Maximizing your savings to ensure you have an income that lasts a lifetime is possible with life annuity. If leaving behind a legacy for your family is not a big concern then a retirement annuity is just what you need. This ensures an additional income for life; however, the amount would vary, based on your age and sex.
How is life annuity taxed?
The investment amount in your life or retirement annuity will grow at a fixed rate, while you continue to take your monthly payouts. This additional monthly income that you enjoy includes an untaxed amount, which is the basis amount, or the purchase price. This is actually a fraction of each payout, called the exclusion ratio, which is fixed at the ratio of the purchase price to the expected total payout. It also factors your life expectancy.
Let's use an example to understand how this approach works. A 65-year-old male, residing in California, gets a total payout of $100,000 over a period of 15 years. These numbers are based on a reliable supplier of life annuity quotations.1
According to the IRS2 table's expected life, a 65-year-old man has fifteen years. The IRS estimate, which does not include a beneficiary, gives $617 per month. However, lower payouts include guaranteed term payouts to beneficiaries. As per this estimate, the total payout of over a period of 15 years at $617/month is $111,060. Which means, the exclusion ratio is an astounding 90% (= $100,000/$111,060).
This would peg your annual income from a $100,000 life annuity investment product at $7,404. Out of this, a meagre $740 is taxable. The 25% marginal tax rate,3 means you net a great return on your investment of $7,219 per year.
Consider the alternative investment of $100,000 in corporate bonds of 10 to 30 years at the current 5.31% rate.4
As an investor, you would earn about $5,310 in total yearly income. Additionally, the entire amount would be taxable at the rate of 25%, bringing your net income down to $3,982. This is half of what your life annuity offers you. However, we must acknowledge here that life annuity does not allow you to leave behind a principal, like other investment options do.
Alternatively, tax free bonds, if obtained at the existing low interest rate, may offer a higher net income, than corporate bonds. However, this would still be lower than life annuity.
Savings on taxable social security?
In case of single individuals, Social Security provisional incomes of over $25,000 are taxed. While, for a married couple that files their taxes jointly, the taxable provisional income limit is raised to $32,000. For the uninitiated, provisional income is the term used by the IRS to determine social security benefits that are subject to tax. The provisional income includes 50% of the social security income and a tax free bond income. Provisional incomes of over $34,000 and $44,000 could lead to as much as 85% of social security benefits being taxed.
As far as Life Annuity is concerned, because only a small portion of the income received is taxable and is included in the provisional income, you save a whole lot more. As per the example mentioned above, the life annuity income adds only $740 to the provisional income. Comparatively, in corporate bonds, it goes up to $5,310 from 5.31% of the bonds. If you happen to be near or within the threshold levels mentioned above, you can secure extra tax savings from your social security income. Thanks to your life annuity, larger parts of your social security remain untaxed. These tax savings can contribute substantially to your overall savings.
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