403B Compared to a Tax Deferred Annuity

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    Types

    • There are different types of annuities available to investors and certain employees. Investors may purchase a tax-deferred annuity in which they make payments to an insurance company into a contract that earns a fixed rate or invests in mutual funds. A 403b is a type of tax-deferred annuity wherein employees make elective salary reductions. These are pretax dollars that grow in the tax shelter until retirement.

    Similarities

    • The IRS provides tax deferral on annuities so long as the money is maintained in an annuity account until age 59 1/2. The IRS treats distributions as income, regardless of how they are invested within the annuity. An annuity owner can invest in aggressive mutual funds without worrying about capital gains.

    Differences

    • A 403b annuity must be an employer-sponsored plan; therefore, employees must be a qualified retirement plan, according to IRS guidelines. Tax-deferred annuities in general can be either a qualified retirement plan or a nonqualified supplemental retirement plan. Qualified plans have contribution limits and all contributions are pretax, making the entire annuity taxable upon distribution. Nonqualified tax-deferred annuities have no contribution limits and contributions are after-tax dollars; only earnings are taxed on distribution.

    Benefits

    • Tax-deferred annuities allow investors to save money toward retirement without increasing annual tax bills for interest or capital gains. Annuities also allow investors to name beneficiaries, helping to pass assets to the next generation in a vehicle that avoids probate. Annuities guarantee that an annuity owner cannot outlive his assets, because they provide a guaranteed lifetime income, if so elected. A 403b plan has special benefits of reducing annual income tax while saving toward retirement and may have employer matching contributions providing employees with "extra free money" from employers for retirement savings.

    Disadvantages

    • The withdrawal restrictions on an annuity are a disadvantage for some. Annuities have many contract requirement. If you pull funds out before the time frames outlined in the contract or by the IRS, you will pay fees to the insurance company and the IRS. Tax-deferred variable annuities are also an expensive investment product, paying mutual fund management fees plus annuity administration fees. The higher fees affect private investors more than 403b plan administrators, who are able to keep fees reduced because of the aggregate plan balance.

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