Planning for retirement is a lifelong journey. For accountants and tax professionals working with clients age 50 and older, there are certain tax perks to recommend that could help boost savings for the future.
These strategies traditionally include utilizing catch-up contributions for 401(k), traditional and Roth IRA, and HSA accounts. While clients may be more familiar with those retirement-saving strategies, there is another tax-advantageous product solution that can help clients save more and potentially grow their retirement savings faster: fixed indexed annuities.
FIAs, like the name implies, guarantee a “fixed” rate of interest for a set period. They are designed to help people manage financial risks associated with retirement. For those wary of riskier options, FIAs provide more predictable earnings to help people manage the threat of outliving their money.
Funds in an FIA earn interest credits based in part on the upward movement of a reference stock market index, such as the S&P 500. Additionally, FIAs provide protection from loss due to market downturns as money in an FIA is not directly exposed to stock market risk. Most importantly, this combination of growth potential and risk protection comes with tax advantages that can nicely complement other savings and investment vehicles in your clients’ retirement portfolios. Here are three key tax benefits of FIAs and how they can contribute to a tax-smart approach for your clients’ retirement planning:
1. No limit on contribution: Unlike other tax-advantaged retirement savings solutions such as 401(k)s and IRAs, FIAs have no IRS-imposed contribution limits for non-qualified funds. This feature might be especially appealing to clients soon approaching retirement who wish to accelerate their savings in their final years of work before retirement, or to high-earning clients who have already maximized their annual contributions to the aforementioned tax-advantaged accounts.
2. Tax-deferred growth: An FIA is an attractive retirement-savings option because it offers predictable tax-deferred growth and can be used as a low-risk savings vehicle that complements a larger investment portfolio. As such, FIAs can also boost savings and increase the potential amount of future retirement income as interest credited to an FIA is not taxed until clients withdraw those earnings. Furthermore, since FIAs help protect savings from market downturns, clients get the benefit of tax deferral with less downside risk than with 401(k) and IRA assets that are invested directly in the market.
However, caution clients that these tax deferral benefits only apply to annuities funded with non-qualified dollars, which is money on which income tax has been paid. Under existing tax laws, the Internal Revenue Code already provides tax deferral to qualified money, so additional tax benefit cannot be obtained by funding an IRA with an annuity. That said, annuities do provide clients with other benefits for qualified funds, such as lifetime income and a death benefit.
3. Favorable tax treatment for retirement income: The most compelling feature of non-qualified FIAs is that the interest earned is only taxable when withdrawn. As income generated from an FIA is typically made up of a combination of interest and the return of the client’s original premium — on which taxes have already been paid — a portion of that income is non-taxable to the annuity owner. As a result, clients can use income from FIAs in conjunction with fully taxable withdrawals from other accounts to help lower their overall tax rate in retirement.
Keep in mind, if your client withdraws money from an annuity before age 59½, they’ll owe the IRS a penalty on the interest earnings withdrawn. So, if your client is much younger, it is your job to inform them of their options so they are confident in the annuity purchase and certain they will not need to take money out before that age.
Managing taxes within retirement planning
With many tax benefits and the ability to provide growth potential while offering downside protection, FIAs can play an integral role in managing taxes within a retirement savings plan. They help clients complement other sources of retirement income, including stocks, bonds and mutual funds held in taxable brokerage accounts; savings in tax-deferred accounts like 401(k)s; and other tax-advantaged vehicles such as Roth IRAs.
As accountants work in tandem with financial professionals to help clients plan with a focus on long-term, tax-advantaged retirement savings strategies, recommending a mix of these tools is vital to helping clients minimize the effect of taxes, manage risk and provide growth potential before and after retirement.