Tax Deferral and Variable Annuities

Q: I read your article regarding low cost variable annuities. I think your article was targeted towards a person that is 40-50 years old. I am 25. I think that over the next 35 years that the tax deferral will actually outweigh capital gains and dividend taxes. I didn't crunch the numbers, just a gut feeling.

Here's another question. If I invest in a mutual fund, will they pass through the capital gains and dividend taxes, or will it be taxed as ordinary income? I'm thinking that I have to invest in the actual stocks to get the advantages of the lower taxes.

A: The last time I ran the numbers it wasn't even close. I couldn't find any situation (from a tax point of view) in which it was better to have the deferral of an annuity and then pay ordinary income taxes versus investing such that it was taxed yearly at capital gains rates.

Whether a mutual fund qualifies for the dividend/capital gains rate depends on what it invests in. So if the underlying instrument would qualify for dividends or capital gains, then that part of your mutual fund holding does to.

Thanks for the questions.

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