- Another potential disadvantage is that there is no capital-gain treatment. All income generated from gains in an annuity is treated as ordinary income.
- Current estate tax laws allow for stock or mutual fund investments passed on to beneficiaries to be valued at the owner's date of death, which is called a step-up in basis. Annuities do not have this feature. Annuities, unlike stock or mutual fund investments, allow for tax deferral, but any gain in the annuity is taxable as ordinary income to the client or the client's beneficiaries at their respective tax rates. If the client's ordinary income rate at retirement is higher than the prevailing long-term capital gains rate, he or she would pay a higher tax rate on any gains withdrawn, but he or she would also have had the benefit of tax deferral. Clients should consult with their tax advisers to determine whether a tax-deferred annuity or a currently taxable investment would be more tax-efficient.
- In an annuity-funded IRA, the minimum distribution amount, governed by the IRA, must be made in the year the owner is 70 1/2. Contributions to the traditional IRA must stop in the year a minimum distribution is made.
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