Annuities Help You Save Tax on Social Security Income

Years ago I saw an article, “When is 7% equal to 9%?’ It illustrated that the yield on a 7% annuity was equal to 9% when the savings on social security tax was factored in. This is a powerful feature of tax deferred annuities. If you offer annuities as a financial professional, to see how you can enhance the benefit of annuities, let’s take the following example of Mr. and Mrs. Smith:

  • Recipients of $20,000 annually of social security benefits
  • $200,000 in the bank, interest reinvested
  • Assume fixed rate is 5% on annuity, bank CD and municipal bond for purposes of illustration
  • Desire is to save taxes

Take a look at the table below and then we show you how annuities save taxes.

Scenario #1Scenario #2Scenario #3 Interest * – $10,000 – $10,000 – $10,000

Pensions – $25,000 – $25,000 – $25,000

Social Security Income – $20,000 – $20,000 – $20,000

Total Income – $55,000 – $55,000 – $55,000
Social Security Subject to tax – $6850 – $1500 – $6850
Adjusted Gross Income – $41,850 – $26,500 – $31,850
Total Federal Tax – $3181 – $1063 – $1681

*Below are three choices under consideration:

Column 1: leave the money in the bank

Column 2: purchase a fixed annuity

Column 3: move the bank money to a tax free bond

Source: hypothetical example of a married couple, both age 65, each with $10,000 social security income and with adjusted gross income of $55,000 using the standard deduction Tax computations by TurboTax™ Intuit Corporation

The purchase of the annuity results in the least tax. How can that be that an annuity, which is tax-deferred, can beat a municipal bond, which is tax-free?

It’s because in the calculation of tax on social security income, IRS includes municipal bond interest in the total income to determine how much social security income gets taxed. Note that the bond interest is not taxed, only its income is included for the “side calculation” to determine how much social security benefit gets taxed. Here’s the basic rule: Social security benefits are tax free for singles with modified adjusted gross income (MAGI) less than $25,000 and couples with MAGI less than $32,000.

What’s MAGI? It’s the usual adjusted gross income plus some “add-backs” like municipal bond interest or interest excluded from savings bonds. From $25,000 to $34,000 for singles and $32,000 to $44,000 for couples, the tax is on as much as 50% of social security income. And for higher amounts of MAGI, the tax can be on as much as 85% of social security income. Therefore, anything that can be used to reduce MAGI, can reduce tax on social security income. In our example, the annuity purchase saves $2000 annually in tax. On a $200,000 annuity, that’s worth 1% and boosts our 5% hypothetical annuity to 6%. But won’t this extra interest all get paid back later? No. Even if our couple distributes the entire annuity many years later and assuming they report interest income of $300,000 in one year, the maximum social security income subject to tax is 85% for that one year. There’s a “cap” on how much social security income gets taxed. Therefore, the annual tax savings from owning the annuity is essentially permanent and does not get paid back later.

Annuity agents who show this to their prospects can have new clients and many annuity leads

Javelin Marketing assists insurance agents, financial advisors, and investment professionals to rapidly meet clients and grow their business. A separate site describes the annuity lead and investment lead service.