A powerful way to make investments grow is through tax-deferred compounding. Fixed annuities can do this. Interestingly, most people don't understand this simple concept which could explain why many people are not rich. what most people don't understand about tax-deferred compounding are two critical issues:
a) If you increase the rate of compounding by a figure, let's say 10%, the additional money you accumulate will be for more than 10%
b) when you grow money in a tax-deferred environment, although you will eventually pay the tax, you will have much more money to live on and spend during your lifetime
As an illustration, an increase in the compounding rate from 6% to 8% (a 33% increase) can increase the investment by simply more than that 33% increase, over the long term. This magical increase is what makes tax-deferred investments so advantageous. Check out the figures below.
Percent Greater Accumulation for 8% more than 6% Compound Rates of $10,000
Year 6% 8% % more
5 13,382 14,693 10%
10 17,908 21,589 21%
15 23,966 31,722 32%
20 32,071 46,610 45%
25 42,919 68,485 60%
30 57,435 100,627 75%
As you see from the above, the longer an investment is at work, the greater the impact of a higher rate. Additionally, as you will see below, the greater the impact of a tax-deferred environment. Note that these are exactly the benefits offered by fixed annuities:
a) the ability to grow money at a higher rate than bonds of comparable maturity
b) the ability to have that growth and a tax-deferred environment
A taxable account yields interest or dividend earnings that will be taxed annually. If the investment returns 10% and will be taxed at the 28% rate, then 28% of the 10% (which is, 2.8%) of the return in investment is taxed. This means that only 7.2% (against the full 10%) can be used for compounding. With fixed annuities, there is no such annual tax on the reinvested interest.
However, fixed annuities, ensure that the earnings are not taxed each year during the accumulation phase. This means the entire 10% return is available for compounding. You may recall Warren Buffet's recent statements in the press that he pays a tax rate of only17%. As ost rich people do, he earns his money at preferential tax rates which allow it to compound faster.
Preserving the effect of taxation in compound rates, we now need to estimate how much more the earnings rate on a taxed account should be to equal the growth potential of a tax-deferred account.
This kind of comparison is essential for individuals looking to preserve capital in the event of a lengthier than anticipated life. They need to take into account whether money in secure opportunities such as treasury bonds or money within fixed annuities is likely to grow in to a greater sum. Since many secure opportunities such as bonds have their income taxed annually, there is a need to evaluate growth rates of the different investment choices.
The tax rate on extra income received will be determined by your own tax bracket. That is, the interest from investments in bonds will be combined with your other income such a part-time work, pension, and social security. So you could easily pay 25% or more on additional earnings.
The particular table below shows your taxable earnings rate (that is be subject to annual taxation) you must achieve to have a compounding rate that would be equal to a tax-sheltered rate:
| Taxable Earning Need to Compound Equally to Tax-Deferred Earning | ||||||
| Federal Income Tax Brackets | ||||||
| 10% | 15% | 25% | 28% | 33% | 35% | |
| Tax-Deferred
Earnings |
Equivalent Taxable Earnings
at Each Tax Bracket |
|||||
| 8% | 8.89% | 9.41% | 10.67% | 11.11% | 11.94% | 12.31% |
| 7% | 7.78% | 8.24% | 9.33% | 9.72% | 10.45% | 10.77% |
| 6% | 6.67% | 7.06% | 8.00% | 8.33% | 8.96% | 9.23% |
| 5% | 5.56% | 5.88% | 6.67% | 6.94% | 7.46% | 7.69% |
| 4% | 4.44% | 4.71% | 5.33% | 5.56% | 5.97% | 6.15% |
If you need to check the earning rates regarding fixed annuities, all you need to do is look up the annuity rates in this blog.
Take note that fixed annuities cannot be surrendered regarding value once they are annuitized. The actual income from fixed annuities is taxed in the same manner as standard income. Withdrawals before the age of 59 ½ are imposed a 10% fee. The income from annuitization is divided directly into two and part is taxed as everyday income and the rest as return regarding capital. All guarantees depend upon the ability of the insurance company to pay your claims. Annuities are essentially long-term assets. As fixed annuities are classified as insurance products, they're subject to insurance related expenses and costs.
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