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A strategy to help boost tax-efficient retirement savings

Learn how tax-deferred variable annuities can help retirement savers.

Key takeaways

  • Investors who have maxed out tax-advantaged retirement options and are seeking additional tax deferral may want to consider a tax-deferred variable annuity.
  • Tax-deferred variable annuities may be appropriate for investors who are subject to high income tax rates, are holding tax-inefficient assets, or are expecting to pay lower taxes in retirement.
  • If you're considering a tax-deferred variable annuity, consider consulting with a financial professional who can help weigh the potential benefits and considerations, and whether this strategy aligns with your retirement goals.

Many investors subject to relatively high marginal tax rates take advantage of tax-deferred vehicles such as IRAs and 401(k)s for their retirement savings. But those who hold the bulk of their liquid investments in taxable accounts that generate large distributions may still find themselves facing a large tax bill every year.

To the extent that you can fund employer plans, IRAs, and similar accounts, you should generally do so before considering other options. However, tax-advantaged accounts have limitations. In 2025, the maximum an individual can contribute to a 401(k) or similar employer plan is $23,500 (those 50 and older can contribute an additional $7,500, plus an additional $3,750 for those ages 60—63); the maximum IRA contribution is $7,000 ($8,000 for those 50 and older). For investors seeking additional tax deferral, one option is a tax-deferred variable annuity.

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How does a tax-deferred variable annuity work?

When you put a portion of your savings into a tax-deferred variable annuity, any earnings are tax-deferred.1 At a future date, you can create a regular income stream or take the assets as you need them. At that point any earnings will be taxed as ordinary income.

A tax-deferred variable annuity has underlying investment options, typically referred to as subaccounts, that are like mutual funds. There are no IRS annual limits to contributions,2 and you choose how you’d like to allocate money among different investments to potentially benefit from market growth. You can also reallocate assets or trade among subaccounts within the annuity, tax-free. "Unlike other tax-deferred vehicles like an IRA, annuities funded with after-tax dollars aren’t subject to required minimum distribution (RMD) rules, which allows for more time to reap the benefits that compound growth can provide,” says Christian Jeeves, a regional vice president in the planning solutions division of Fidelity.

Tax-deferred variable annuities aren’t the right choice for everyone, however. Money invested in a tax-deferred annuity is designed to be used in retirement; upon withdrawal, taxable amounts will be subject to ordinary income tax and if taken prior to age 59½ may also be subject to a 10% tax penalty. You’ll also be subject to an annual annuity charge, which can vary depending on the annuity product and any specific benefits you choose. If you are focused solely on tax deferral and are not interested in additional benefits such as a guaranteed minimum death benefit, you may want to consider a low-cost deferred variable annuity.

Fidelity’s Personal Retirement Annuity®, 3 for example, charges 0.25% per year, well below the industry average of 1.03%.4

Who should consider a tax-deferred variable annuity?

Answering these 5 questions can help you determine if a tax-deferred variable annuity may be a strategy for you to consider.

1. Are you holding a lot of tax-inefficient assets in taxable accounts? Tax-inefficient assets are defined as those assets with relatively low tax efficiency—that is, those that tend to deliver most or all of their total returns in forms that are heavily taxed, such as bonds. In general, investors who hold large amounts of tax-inefficient assets are more likely to benefit from a low-cost tax-deferred variable annuity. (These tax-efficient investing strategies can also potentially help boost your after-tax returns.)
 
2. Are you currently subject to high tax rates? Generally speaking, the higher your marginal income tax rate, the more you should consider the potential advantage of tax deferral offered by a tax-deferred investment. Also, in some cases—depending on the state you live in—even if you are in a lower federal tax bracket, you still may be subject to a combined income tax rate that is relatively high.
 
3. Do you expect lower taxes in retirement? With a tax-deferred variable annuity, all gains are taxed as ordinary income upon withdrawal (plus any Medicare surtax, and state and local taxes). There are some reasons you may see lower income taxes at retirement, however, including moving to a state that has lower taxes than your current state or receiving less ordinary income than in previous years. If either of these situations applies, then an annuity may not only defer, but also help reduce, your taxes over the long run. And with no RMDs, you can exercise greater control over the withdrawals, perhaps opting to take more income in years when your taxable income is lower or withdrawing less in years where the income might push you into a higher tax bracket.
 
Hypothetical example: The power of tax deferral 5, 6
Bar graph showing the potential value of a $100,000 investment in 20 years at a 6% hypothetical rate of return, in a taxable and tax-deferred variable annuity account.
This hypothetical example is not intended to predict or project investment results. Your actual results may be higher or lower than those shown here. Assumptions included: $100,000 investment, 20-year horizon, 0.25% annual annuity charge for the tax-deferred variable annuity (VA), marginal federal income tax rate of 32% for the entire period, and a 6% annual rate of return (equivalent to a 5.74% net annual rate of return for the VA) with the gain assumed to derive entirely from income (characterized for tax purposes as ordinary income, for example, bond portfolio income). Investments that have the potential for a 6% annual rate of return also come with the risk of loss. This rate of return is not guaranteed. For year-by-year details, see disclosures 7 and 8 below.

4. Do you have a long window before taking income in retirement? The advantage of tax deferral is proportional to the amount of time available before the assets are withdrawn from the deferred account. In general, if you won’t need access to this money for at least 10 years, you may be a good candidate for a low-cost tax-deferred variable annuity. However, a shorter time frame may still make sense, depending on other considerations such as the tax-efficiency of your overall holdings and your tax bracket.

5. Might your estate be subject to estate and gift taxes? Should you die while owning a tax-deferred variable annuity, the surrender value of the annuity contract would be included in your estate, so if you think your estate may be subject to gift and estate taxes, you may want to consider planning strategies to reduce or defer your tax liability. For example, you may want to consider distributing the gains during your lifetime and paying income taxes. Also consider advantageous post-death distribution options, which include leaving the annuity to a spouse, who can continue tax deferral, generally until age 95, naming a non-spouse beneficiary, who may be eligible to elect to take distributions over their life expectancy and stretch out the income tax, or naming a charity as beneficiary. Talk to your attorney or estate planning professional about the best ways to manage the income and estate tax implications of a tax-deferred variable annuity.

Additional tax-deferred variable annuity considerations

No matter which provider you choose for a tax-deferred variable annuity, you will generally pay more if you need to address a specific risk with a guarantee, such as a guaranteed living benefit. This could potentially provide income or asset protection from down markets. “It’s important to ensure that you understand the features of an annuity, and aren’t paying for features you don’t need,” explains Jeeves.

It's also critical to choose a provider in sound financial health. “If you are planning to enter into a multi-decade contract with a provider, you want to make sure they will be there to pay out the obligations,” Jeeves says.

The bottom line

Annuities can be powerful tools for tax-deferred savings and offer guaranteed income that can potentially improve your confidence in retirement. However, they are not for everyone, so it's important to consider all the different pros and cons an annuity may provide for achieving your personal goals. If you’re considering a tax-deferred variable annuity, talk to a financial professional who can assess how it might fit into your unique retirement savings plan.

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1. Withdrawals of taxable amounts from an annuity are subject to ordinary income tax, and, if taken before age 59½, may be subject to a 10% IRS penalty. 2. Contributions may be limited by the insurance company provider. 3. Fidelity Personal Retirement Annuity (Policy Form No. DVA-2005, et al.) is issued by Fidelity Investments Life Insurance Company and, for New York residents, Personal Retirement Annuity (Policy Form No. EDVA-2005, et al.) is issued by Empire Fidelity Investments Life Insurance Company®, New York, N.Y. Fidelity Brokerage Services, Member NYSE, SIPC, and Fidelity Insurance Agency, Inc., are the distributors. 4. Data as of 12/31/2023 for nongroup open variable annuity contracts. Source: Morningstar, Inc. Underlying fund fees apply and surrender charges may also apply. 5. In the taxable account, it is assumed taxes incurred on the income are paid annually from the income itself, with the remainder reinvested. For the VA, it is assumed that all income —less the 0.25% annual annuity charge—is reinvested. The VA pre-tax results assume, the investor has not taken any withdrawals and all taxes continue to be deferred. The VA post-tax results assume, the investor liquidates the VA at the end of time period and pays taxes on the gain out of the proceeds. If the assets in the VA were liquidated entirely in one year, its proceeds may increase the tax bracket to the marginal federal income tax rate of 40.8% (37% ordinary income tax plus 3.8% Medicare surtax), which would minimize and potentially eliminate any savings of the VA. To avoid this, the VA would need to be liquidated over the course of several years or annuitized, which would lengthen the deferral period. 6. State and local taxes, the 3.8% Medicare surtax, inflation, and fund and transaction fees were not taken into account in this example; if they were, performance for both the taxable account and the VA would be lower. This example also does not take into account capital loss carry forwards or other tax strategies that could be used to reduce taxes that could be incurred in a taxable account; to the extent they apply to your situation, the comparative advantage of a VA would be diminished. Lower maximum tax rates on capital gains, dividends, and interest income would make the taxable investment more favorable. Changes in tax rates and tax treatment of investment earnings may impact the comparative results. Consider your current and anticipated investment horizon and income tax bracket when making an investment decision, as the illustration may not reflect these factors. VAs are generally not suitable for investors with time horizons of less than 10 years. 7. The year-by-year pre-tax account values for the low-cost VA at the 5.74% and -0.25% (0% less 0.25% annual annuity charge) net annual rates of return shown above are: $105,735/$99,750 for year 1, $111,799/$99,501 for year 2, $118,211/$99,252 for year 3, $124,990/$99,004 for year 4, $132,158/$98,756 for year 5, $139,737/$98,509 for year 6, $147,751/$98,263 for year 7, $156,225/$98,017 for year 8, $165,184/$97,772 for year 9, $174,658/$97,528 for year 10, $184,674/$97,284 for year 11, $195,265/$97,041 for year 12, $206,464/$96,798 for year 13, $218,305/$96,556 for year 14, $230,824/$96,315 for year 15, $244,062/$96,074 for year 16, $258,059/$95,834 for year 17, $272,859/$95,594 for year 18, $288,507/$95,355 for year 19, $305,053/$95,117 for year 20. ($305,053 comes to $239,436 after federal income taxes of 32% have been deducted, since there is no gain at a 0% rate of return, income taxes are not applicable). 8. The year-by -year post-tax account value for the taxable account at a 6% rate of return shown above is: $104,080 for year 1, $108,326 for year 2, $112,746 for year 3, $117,346 for year 4, $122,134 for year 5, $127,117 for year 6, $132,303 for year 7, $137,701 for year 8, $143,320 for year 9, $149,167 for year 10, $155,253 for year 11, $161,587 for year 12, $168,180 for year 13, $175,042 for year 14, $182,184 for year 15, $189,617 for year 16, $197,353 for year 17, $205,405 for year 18, $213,786 for year 19, and $222,508 for year 20.

Before investing, consider the investment objectives, risks, charges, and expenses of the annuity and its investment options. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.

Investing in a variable annuity involves risk of loss – investment returns, contract value, and, for variable income annuities, payment amounts are not guaranteed and will fluctuate.

Guarantees apply to certain insurance and annuity products and are subject to product terms, exclusions and limitations and the insurer's claims paying ability and financial strength.

Fidelity does not provide legal or tax advice, and the information provided is general in nature and should not be considered legal or tax advice. Consult an attorney, tax professional, or other advisor regarding your specific legal or tax situation.

Fidelity insurance and annuity products are issued by Fidelity Investments Life Insurance Company (“FILI”), 900 Salem Street, Smithfield, RI 02917 and, in New York, by Empire Fidelity Investments Life Insurance Company® (“EFILI”), New York, N.Y. FILI is licensed in all states except New York; EFILI is licensed only in New York. Fidelity Insurance Agency, Inc. and, in the case of variable annuities, Fidelity Brokerage Services, Member NYSE, SIPC, are the distributors. A contract's financial guarantees are subject to the claims-paying ability of the issuing insurance company.

Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917

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