Wealth InFormation: Taxation Risk
Wealth is always InFormation, whether one chooses to actively manage their formation or let finances and taxes play out as they may without the proper information.
We have been having conversations with our clients recently about investments in Certificates of Deposit versus fixed annuities. A CD is issued by a bank or a credit union which provides a principal guarantee as well as a guaranteed rate of return (interest rate). There is generally a period of illiquidity, where the investor commits to a length of time that their money will stay inside the CD.
An annuity is issued by an insurance company and essentially is a contract between the issuing company and the owner where certain features are guaranteed by the issuing company, sometimes with an associated cost. Annuities come in many different flavors, but the one category of annuity that is somewhat similar to a CD is a multi-year guaranteed (fixed) annuity.
A MYGA and a CD have similarities and differences. Among the similarities, both may offer a set, guaranteed rate of return for a specified period of time, with no fees. Both may have penalties from the issuing company if money is withdrawn before the CD or annuity contract reaches it’s maturity date. But the two very distinct differences that investors should be aware of, come from how the IRS treats CDs versus annuities.
In a non-qualified (meaning non-retirement) account, the interest earned on a CD is taxed each year, whether you receive the interest earned in cash or reinvest it. I was talking with a few different clients recently about their investment options including their associated tax implications, especially for those who have large balances of conservative money. If invested in a CD, not only are they paying taxes on money they are not currently using, but that taxation can impact other things like health insurance credits, trigger further taxation on social security, increase Medicare premiums, and even push them into higher income and capital gains tax brackets.
Conversely, IRS rules grant tax-deferral benefits to all annuities, meaning that you do not pay taxes on the growth of an annuity until the money is withdrawn. This can in turn, not only save you tax payments in the current tax year, but also save in other areas of your financial life, like those mentioned in the paragraph above. In exchange for the tax treatment, there is another IRS rule that younger investors in particular need to be aware of, and that is the 10% federal penalty for withdrawals made prior to age 59 ½, with little exception. Similar to retirement accounts, if an annuity owner takes a premature distribution from an annuity contract, they will not only be taxed, but penalized. CD’s on the other hand, do not impose this IRS penalty for withdrawing money prior to 59 ½.
Each CD or annuity will have elements that differ from the next. It is important to understand all of the features, benefits and rules about the account for which you are considering a commitment of your money.
Wealth is always in formation and with the proper information, you may avoid risks including risks to your principal, as well as taxation risk.
LouAnn Schulfer of Schulfer & Associates, LLC Wealth Management can be reached at (715) 343-9600 or louann.schulfer@lpl.com TheWealthInformationLady.com SchulferAndAssociates.com , or louann.biz
Securities and advisory services offered through LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
CDs are FDIC insured to specific limits and offer a fixed rate of return if held to maturity. Annuities are not FDIC insured. Annuities are long-term, tax-deferred investment vehicles designed for retirement purposes. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Withdrawals made prior to age 59 ½ are subject to 10% IRS penalty tax. Surrender charges apply. Guarantees are based on the claims paying ability of the issuing insurance company.
Fixed annuities are long-term investment vehicles designed for retirement purposes. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
