If planning for retirement, you might have considered these two investment options: annuities and dividend stock. Both are an excellent option when looking to maximize your retirement savings. But which one is right for you? Let’s dive deeper.
What are annuities?
Annuities are insurance products that guarantee you a stream of income once you retire. You can get your income either on a monthly, quarterly, annual, or lump sum basis. Annuities are tax-deferred. You are taxed when you make a withdrawal. The payments you receive are based on the type of annuity you picked.
Benefits of annuities
- Guaranteed death benefits
After your death, the insurer pays your beneficiary at least the amount you had put. For example, variable annuity makes sure your heirs or beneficiary receive maximum benefits. When it comes to dividend stock, it is not possible to add death benefits to an ordinary portfolio of a dividend stock.
- Flexibility to use a portion of your account to pay for other uses
You can use a fraction of your annuity account to pay for nursing home care or assisted living. Your insurance company will facilitate this without complicated procedures. That is not possible with an ordinary portfolio of a dividend stock.
Dividend growth prospects
A dividend portfolio is very flexible. With one, you get income from your dividend plus capital gains<span style=”font-weight: 400;”> from the stocks price growth. This is not possible when you set up an annuity as the upside on your portfolio becomes very limited. Depending on the type of annuity you pick, you either have no growth on an immediate annuity or minimal growth due to high fees.
The volatility of dividend stocks is one thing you need to prepared to face if you have a dividend portfolio. But if you will not be selling your stocks when the market goes down, no need to worry.
Two major differences pop up when it comes to taxation between these two options. The first difference is how your earnings are taxed. With annuities, you are taxed at your ordinary-income rate. When it comes to dividend stocks, you pay a lower rate on the qualified dividends, and if you fall in the lowest two tax brackets, you are exempted from taxes. Besides, if you unload your stock for a gain, the capital gains tax tops out at 20% for the highest tax bracket. This can determine the taxes you will pay in retirement.
The second difference is when you pass on assets to your estate as there exist different rules for what your heirs cost basis will be. With an annuity, your hears get the basis that you had. When it comes to stocks, they get a step-up basis. In a nutshell, their cost basis is the prices of the stock on the day you passed away. Again, this can make a significant difference on how much taxes they will pay even if you had a 100% gain on the stock.
How the fees add up
Fees have the potential to destroy your portfolio. With annuities portfolio, be prepared to pay more fees. You will not only pay large commissions upfront but also pay surrender charges if you want to walk out of the contract, among other fees.
A dividend portfolio is much lenient compared to an annuity portfolio. You just pay a transaction fee to purchase the shares. No other fees until you sell the stock. If you live off your dividends and don’t sell the stock, then you just pay only one fee.
When it comes to stock investments, you can invest in mutual funds, convertible bonds, stocks, and exchange-traded funds. You are guaranteed tax-breaks on profits from a stock market investment that you hold for more than a year. That is the capital gains tax rate. This rate varies from 0% to 20% based on your gross income. This rate also applies to any qualified dividends you get from your stock investment.
This is not the case with annuities where you don’t have to cash in your stock holding and can leave them to a beneficiary. With inherited stocks, your beneficiary receives a new cost basis on the day you die.
Tax-sheltered stock investments
You can invest in stocks through your IRA or employer plan. Some employer plans may limit your investments. 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.
Determining which option is right for you is very crucial when planning for your retirement. Both options are great, but you may want to compare the benefits and costs of each to make an informed decision. You can even consult a financial advisor if you find yourself in a bind to pick an option that suits you best.