Tax Deferred Annuity vs. Taxable Investment

What is a Tax Deferred Annuity?

A Tax Deferred Annuity is an annuity that meets government guidelines to qualify for tax-deferred treatment. It is not subject to federal income tax at the time it is deposited. It is however, subject to taxation when it is withdrawn from the account.

Benefits of deferred taxation

So what's the difference if the money deposited is taxed now or later?

There are a number of benefits to deferred taxation.

Lower tax rate - Normally a person falls into a higher federal income tax bracket during the income producing years rather than in the years following retirement.
Triple-compounding - Your principal earns interest. Your interest earns interest. And, the taxes you don't have to pay each year earns interest.

The power of triple compounding

The charts below illustrate the power of triple compounding. The comparison assumes $20,000 invested for 30 years until investor's age of 60. Investor begins investing while in a 31% tax bracket.

Compare $20,000 Invested for 30 Years (Assuming 31% Tax Bracket, Investor Age 60)

Taxable Investment Earning 5.25% Annually
Year	Interest	Taxes	Balance
1	$1,050.00	$ 325.50	$20,724.50
2	$1,088.04	$ 337.29	$21,475.25
3	$1,127.45	$ 349.51	$22,253.19
4	$1,168.29	$362.17	$23,059.31
5	$1,210.61	$375.29	$23,894.63
10	$1,446.36	$448.37	$28,547.67
15	$1,728.01	$535.68	$34,106.80
20	$2,064.51	$640.00	$40,748.47
25	$2,466.53	$764.63	$48,683.48
30	$2,946.84	$913.52	$58,163.69

Annuity Rate 5.25% (AM Best Rating Superior)
Year	Interest	Taxes	Balance
1	$1,050.00	$0.00	$21,050.00
2	$1,105.13	$0.00	$22,153.13
3	$1,163.14	$0.00	$23,318.27
4	$1,224.21	$0.00	$24,542.48
5	$1,288.48	$0.00	$25,830.96
10	$1,664.13	$0.00	$33,361.92
15	$2,149.31	$0.00	$43,088.52
20	$2,775.93	$0.00	$55,650.89
25	$3,585.25	$0.00	$71,875.79
30	$4,630.53	$0.00	$92,831.02

*The results...*	Taxable Investment	Annuity
Total Interest Earned	$55,309.70	$72,831.02
Total Taxes Paid	$17,146.01	$0.00
Taxes Due at End	$0.00	$22,577.62*
Net Interest Earned	$38,163.69	$50,253.41*

The scenario above assumes that at age 60 the annuitant is still in the higher income tax bracket of 31%. If however, the annuitant is in a lower tax bracket at that time the savings would be even more. For example, if the annuitant is then in a 25% tax bracket the Net Interest Earned would be $54,623.26, and if the annuitant is then in a 15% tax bracket the Net Interest Earned would be $61,906.36.