Should Annuities Be Purchased from Tax-Sheltered Assets? (Journal Article)

Retirees who purchase an annuity may assume that retirement savings accounts are ideal for funding retirement income. Annuities, however, are a tax-favored investment. The authors investigate the relative benefits of purchasing an annuity from tax-deferred and taxable accounts for various payout levels, tax rates, asset tax efficiency, and assumed portfolio rates of return. Considerable evidence is found that investors are better off using nonqualified accounts to purchase annuities, although the benefits vary significantly by investor characteristics and the tax efficiency of investments held in nonqualified savings. In some cases, selecting the right account increases the after-tax income of an immediate annuity by over 10 percent. A 15-year deferred annuity purchased from nonqualified versus qualified bonds earning 4 percent provides over 30 percent more after-tax income for a 65-year-old with a 40 percent marginal tax rate.

Author: David M. Blanchett, PhD, CFA, CFP, is head of retirement research for Morningstar Investment Management LLC. He is currently an adjunct professor of wealth management at The American College, an expert panelist for the Wall Street Journal, a member of the executive committee for the Defined Contribution Institutional Investment Association (DCIIA), and a member of the ERISA Advisory Council. He received a doctorate in personal financial planning from Texas Tech University. His research has received best paper awards from the Academy of Financial Services (2017), the CFP Board (2017), the Financial Analysts Journal (2015), the Journal of Financial Planning (2007, 2014, 2015, 2018), and the Retirement Management Journal (2012).

Author: Michael Finke, PhD, CFP, is a professor and Frank M. Engle Distinguished Chair in Economic Security at The American College of Financial Services. Dr. Finke served as the editor of the Journal of Personal Finance and is a contributing editor at Investment Advisor magazine. He received a doctorate in consumer economics from the Ohio State University in 1998 and in finance from the University of Missouri in 2011. He received the Montgomery Warschauer best paper award from the Journal of Financial Planning in 2013 and 2014, and the CFP Board Center for Financial Planning Best Paper Award in investments in 2017.