Measuring the Tax Benefit of a Tax-Deferred Annuity

October 1, 2009

In this study, David Babbel shows how to measure the size of tax benefit arising from the purchase of fixed annuities – both deferred and immediate. They demonstrate how the size of tax benefit available from tax deferral depends on five factors:

  1. The length of time the annuity is held during the accumulation and decumulation phases of ownership;
  2. Whether a deferred annuity is annuitized (either by conversion or by a 1035 exchange) at the end of the surrender period, or taken as a lump sum distribution;
  3. The level of yields;
  4. Tax rates on ordinary income; and
  5. The differential between tax rates on ordinary income and tax-preferred treatment of dividends and capital gains.

They also provide a set of formulae that can be used to estimate the size of tax benefit arising from tax deferral under varied scenarios.