Annuity tax deferral is the feature that allows earnings inside an annuity to grow without current income taxation until withdrawals or annuitization occur. This applies to nonqualified annuities funded with after-tax dollars, where gains are taxed as ordinary income when distributed, typically on a last-in, first-out (LIFO) basis for deferred contracts. Tax deferral can enhance compound growth compared with taxable investments, especially over long holding periods. However, it comes with tradeoffs, including ordinary income treatment instead of capital gains rates, potential 10 percent penalties on early distributions, and beneficiary tax considerations.

Advisors emphasize annuity tax deferral when positioning annuities as long-term accumulation or income tools, particularly for high-income clients who have maximized qualified plan contributions. They compare after-tax accumulation in annuities versus taxable bonds or CDs, illustrating how deferral can improve net outcomes if funds remain invested. Advisors also caution that tax deferral is not tax avoidance and that eventual withdrawals may raise taxable income in retirement. In estate planning, they discuss how deferred gains will be taxed to beneficiaries. Understanding annuity tax deferral allows advisors to present a balanced view of its advantages and limitations within a broader tax strategy.