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  • 5-Minute Article
  • |
  • Sep 27, 2024

How Registered Index-Linked Annuities Are Taxed and How They Can Benefit Your Portfolio

Explore how tax deferral could help your portfolio in the long term.

Questions this article can help you answer:
  • How does tax deferral generally impact long-term growth in my portfolio?
  • How could I benefit from adding a registered index-linked annuity (RILA) to a portion of my portfolio if I’m currently in a higher tax bracket?
  • How can I work with tax and financial professionals to integrate a RILA into a tax-planning strategy?
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As you consider how taxes impact you now and in retirement, you may be looking for a product that helps provide you with tax-deferred growth opportunities. Registered index-linked annuities (RILAs) have increased in popularity in the past several years.1 RILAs can be appealing because they provide a level of downside protection while offering the opportunity for market-linked growth, which is typically tax-deferred. When you choose a RILA, you select a term (the amount of time the crediting strategy is in effect), a level of downside protection against market downturns, and a market index to track. With a RILA, you typically don’t pay taxes on the growth in the account value until you begin taking withdrawals.

Tax deferral may help your RILA (also known as a buffered annuity) build account value, and you may be able to use a RILA as part of your overall tax strategy. It’s a good idea to consult with a financial professional as well as a tax professional when making decisions about your investments and potential tax implications.

For definitions of words and phrases related to RILAs, view our RILA dictionary.

The Long-Term Impact of Tax Deferral
 

The impact of tax deferral can be an important factor when considering a RILA for a portion of your portfolio. Because growth within a RILA isn’t generally subject to taxes until withdrawals or distributions are taken, compounding can occur on the interest that is:

  • Credited to the account at the end of the term
  • Received on the interest
  • Earned on amounts that would otherwise have been paid in taxes if the investment did not have tax deferral

When comparing two financial products – one that has tax deferral and one that does not – if the growth rate is the same, the tax-deferred investment would grow faster. This is because you’re not paying the taxes you otherwise would have owed if tax was owed each year rather than having the investment grow tax-deferred.2 By contrast, other investments that don’t receive tax deferral may be subject to annual taxation, such as taxation on interest or dividends, as well as potential taxation on capital gains when you make a transaction.3

A RILA’s growth potential is typically based on the performance of a tracked index or indices, like the S&P 500® Index,A so you may experience similar growth as other index-linked investments but with the added benefit of tax deferral, which may not be available with other investment types.

Additionally, if you own a RILA, you have the option at the end of the term to reallocate your funds within the RILA and choose a new index strategy. An index strategy is an allocation option that provides a return based on the performance of the tracked index, level of protection, crediting strategy, and chosen term. This may allow you to diversify your investment or choose a different level of protection; however, since the funds are being reallocated within the annuity, they aren’t generally subject to tax at the time because you’re not taking a distribution.

Tax-Deferred vs. Taxable Growth

Deferring taxes on investment growth can have a significant effect on overall results.

  • Investment amount: $100,000
  • Current age: 45
  • Expected annual rate of return: 7%
  • Current tax rate: 32%

Tax-Deferred vs. Taxable Growth

Source: 360 Degrees of Financial Literacy: Variable Annuity Calculator. The American Institute of Certified Public Accountants. Assumes no surrender charge on the annuity.

The Potential Benefits of RILAs for Higher Earners
 

In comparing taxable and tax-deferred investment growth, you’ll want to consider whether you believe it’s best for your financial situation to be subject to taxes on your gains today or in the future. One way to think about this is that if you expect your tax bracket to be lower when you begin taking distributions from an investment, you might determine that a tax-deferred product is more appropriate. In addition, if you’re currently maximizing annual IRA and retirement plan contributions, a RILA gives you the opportunity for a different savings strategy of tax-deferred growth. Consult with a qualified tax professional for guidance.

RILAs and Retirement Taxes
 

RILAs might also help you with tax planning in retirement, particularly if you’re interested in keeping your taxable income lower. Generally, the amount of taxable income can affect:

  • Your tax rate4
  • The percentage of your Social Security benefits that could be taxed, up to 85%5
  • Premiums for Medicare Part B, which helps cover care such as outpatient and physicians’ services, and Medicare Part D, which covers prescriptions6

However, since RILAs are generally a tax-deferred investment, any gains on your account aren’t included in taxable income until a withdrawal is taken.7

Tax Deferral Is Just One Benefit of RILAs
 

Deferring taxes is just one of the potential benefits of RILAs, and taxes shouldn’t be the sole factor in determining an investment strategy, as tax laws are dynamic and subject to change. Talk to a financial professional or qualified tax professional about the benefits a RILA may provide, such as growth opportunities and a level of downside protection, and how those features may fit within your portfolio and plans for retirement.

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Prospectuses

A The S&P 500® is a product of S&P Dow Jones Indices LLC or its affiliates (“SPDJI”) and has been licensed for use by Brighthouse Financial, Inc. S&P®, S&P 500®, US 500, The 500, iBoxx®, iTraxx® and CDX® are trademarks of S&P Global, Inc. or its affiliates (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”); and these trademarks have been licensed for use by SPDJI and sublicensed for certain purposes by Brighthouse Financial, Inc. Brighthouse Financial products are not sponsored, endorsed, sold, or promoted by SPDJI, Dow Jones, S&P, or their respective affiliates; and none of such parties make any representation regarding the advisability of investing in such products, nor do they have any liability for any errors, omissions, or interruptions of the S&P 500®.

1 U.S. Annuity Sales Post Another Record Year in 2023. LIMRA, January 24, 2024.

2 This example does not take any fees associated with the products into consideration.

3 It’s important to talk to a tax professional because the tax rates between tax-deferred and taxable investments are generally different. For example, although a tax-deferred annuity generally receives tax deferral until a withdrawal is taken, taxable amounts are generally subject to ordinary income tax and not capital gain tax rates, which may be lower. In addition, taxable amounts withdrawn from an annuity may be subject to a 10% additional federal income tax penalty if made before age 59½, unless an exception applies. Generally, this additional tax may not apply to an investment that does not receive tax deferral. Both annuity withdrawals and taxable investments may also be subject to a Net Investment Income Tax for higher income taxpayers; however, such tax generally would not apply to an annuity until amounts are withdrawn. The Net Investment Income Tax also generally does not apply to IRAs and certain tax qualified retirement plans. Consult with a tax professional.

4 Applicable federal income tax rates are generally based on the amount of taxable income. Refer to IRS Publication 17 Your Federal Income Tax and consult with a tax professional.

5 Refer to IRS Publication 17 Your Federal Income Tax and IRS Publication 915 Social Security and Equivalent Railroad Retirement Benefits and consult with a tax professional.

6 Refer to Medicare and You (Medicare.gov) as well as Rules for Higher-Income Beneficiaries (Social Security Administration).

7 Withdrawals of taxable amounts are subject to ordinary income tax. Withdrawals made before age 59½ may also be subject to a 10% federal income tax penalty. Distributions of taxable amounts from a non-qualified annuity may also be subject to the 3.8% Net Investment Income Tax that is generally imposed on interest, dividends, and annuity income if the modified adjusted gross income exceeds the applicable threshold amount. Withdrawals will reduce the death benefit and account value. Withdrawals may be subject to withdrawal charges.

This material is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax, accounting, investment, or fiduciary advice. Brighthouse Financial and its affiliates did not consider any individual’s circumstances in preparing this information. Clients should confer with their tax, legal, and accounting professionals in addition to consulting with a financial professional.

Buying an annuity to fund a qualified retirement plan or IRA should be done for the annuity’s features and benefits other than tax deferral. Tax deferral is generally a feature of a qualified retirement plan or IRA, so an annuity would not provide an additional tax deferral benefit. References throughout this material to tax advantages, such as tax deferral and tax-free transfers, are subject to this consideration. The product described in this material is not made available to employer-sponsored qualified retirement plans. For non-qualified annuities, tax deferral is not available to corporations and certain other entities.

Annuities are issued by, and product guarantees are solely the responsibility of, Brighthouse Life Insurance Company, Charlotte, NC 28277 and, in New York only, by Brighthouse Life Insurance Company of NY, New York, NY 10017 (“Brighthouse Financial”). Variable products are distributed by Brighthouse Securities, LLC (member FINRA). All are Brighthouse Financial affiliated companies. Annuities are long-term investments designed for retirement purposes. The contract prospectuses and contracts contain information about each contract’s features, risks, charges, expenses, exclusions, limitations, termination provisions, and terms for keeping the contract in force. Prospectuses and complete details about each contract are available from a financial professional and should be read carefully. Product availability and features may vary by state or firm.