Annuities and stock investments each have benefits. These benefits overlap if you invest your annuity in nothing but stocks. To make an apples-to-apples comparison between the two investment types, you can compare stock investments in your regular brokerage account to non-qualified annuities. Likewise, compare stocks you hold in a retirement account to qualified annuities. You can buy annuities that lock in your return, however, which isn't something you can do with stock investments.
Non-qualified annuities offer a tax break. The money you contribute grows tax-deferred until you cash out the annuity. This allows your investments to grow faster because they don't suffer a tax drag. You can choose from different types of non-qualified annuities that affect what you can invest in and how long the annuity will last. For example, if you buy a variable annuity, you can invest in stocks, bonds, mutual funds and other investments. You can purchase a life annuity, which makes payments for the rest of your life, no matter how long you live. Whatever type you buy, most annuities provide a death benefit to your beneficiaries. You can set up an annuity to pay a death benefit that exceeds the annuity’s cash value. You'll also want to know all the taxes and fees associated with your non-qualified annuity. You pay your ordinary tax rate on annuity distributions in excess of the contract’s cost basis. You might have to pay a 10 percent early withdrawal penalty if you take money out before age 59 1/2. If you cash in an annuity before it begins paying out, you might have to pay substantial surrender fees to the annuity provider.
You can invest in the stock market in many ways, including stocks, options, convertible bonds, mutual funds and exchange-traded funds. You get a tax-break on profits from stock market investments that you hold for more than one year, namely the capital gains tax rate. This rate ranges from 20 percent down to 0 percent, depending on your gross income. This same rate also applies to any qualified dividends you receive from your stock investments. Unlike annuities, you never have to cash in your stock holdings and can bequeath them to a beneficiary. Inherited stocks receive a new cost basis on the day the deceased dies. The effect is that a beneficiary treats the stocks as if they were purchased at the prices that existed on the deceased's final day. This reduces the capital gains when the beneficiary sells the stock. You can sell your stocks any time without early-withdrawal penalties.
You hold qualified annuities in an employer plan or an individual retirement account. These annuities normally have no cost basis because you deduct your contributions. Because they have no cost basis, you include all of your annuity distributions, whether lump sum or periodic, in your taxable income. In addition to taxes, qualified annuities are subject to the early-withdrawal penalty. The tax situation changes if you hold a qualified annuity in a Roth account. You receive no tax deduction for contributions to a Roth annuity but distributions are tax-free to you and your beneficiaries.
Tax-Sheltered Stock Investments
You normally can invest in stocks through your employer plan or IRA. Some employer plans might limit your investments or choose them for you. Sheltered stock investments share the same tax benefits as those available from qualified annuities. In fact, a qualified annuity invested in stocks should perform similarly to the same portfolio held directly in an IRA or employer plan. However, you avoid the annuity management and surrender fees if you invest your retirement account directly in stocks. Stocks held in a sheltered account don’t receive capital gains treatment. Naturally, you can divide your retirement investments between annuities and stock investments.
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