Annuities Have Big Tax Advantages Over CD’s

The most important skill a financial planner brings to the table for their client is not knowledge, designations, or even experience. A planner’s most important asset is his or her ability to put down the pen and listen to each client’s wants, needs, anxieties, hopes, and dreams. It is only then that he or she can best pick the products and strategies that will help meet the client’s goals.

Invested in Bank CD’s

Dear FedNav,

I am an 82-year-old widow in very good health. My husband and I built a nice nest egg of about $2 million. I don’t need it, as I also have a good pension and Social Security benefits. I simply want to pass that money on to my three kids. I have the money invested in bank CD’s that average about 5%. But I recently spoke with two different brokers who have different suggestions. One said I should put the money in stocks and bonds, while the other said to invest in tax-deferred annuities. What should I do?

-Sharing the Wealth

Dear Sharing the Wealth,

First, we hope you don’t have all those CD’s in one financial institution. Remember, FDIC only covers each individual, not each CD, for $250,000 per institution. Anything over that limit is uninsured and at risk should the bank or credit union default. As to your question of picking a stock and bond portfolio or a tax-deferred annuity, both have advantages and disadvantages you should consider.

Stocks and Bonds

Most of your stock and bond portfolio would be taxed at the dividend tax rate and the long-term capital gains rate, which can be 0 to 20% for most investors, depending on taxable income. A huge advantage for the stock and bond portfolio is that it would be inherited as tax-free income for your children! It also has the potential of outperforming both CD’s and tax-deferred annuities. However, people can and do lose money in stocks and bonds, even on the principal amount invested.

Annuities

A tax-deferred annuity has the advantage of principal and interest guarantees, which are based on the claims-paying ability of the issuing company. Furthermore, you would not pay income taxes on the deferred interest until you die. However, your kids would owe ordinary income tax on the tax-deferred interest when the funds are inherited, and there may be additional costs associated with the features of an annuity.

What’s Your Best Option?

Of the options discussed, stock and bond portfolios offer the lowest inheritance tax rate and highest growth potential. But, if you are not comfortable with the risks and you find the annuity expenses acceptable, then tax-deferred annuities may be your best option. CD’s are FDIC insured and offer a fixed rate of return, but they are also taxed at your ordinary income tax rate each year. You should take all of the pros and cons into consideration before making your decision.