The most simple definition of a tax-deferred fixed annuity is a long-term investment vehicle that provides several tax advantages. More specifically, it's a contract between you and an insurance company for a guaranteed interest-bearing policy. This policy also guarantees certain income options. What the insurance company does is it credits interest to your principal investment, and you don't pay taxes on these earnings until you make a withdrawal or begin receiving an annuity income. Simply, your annuity investment earns a competitive return that is very safe.

Tax-deferred means postponing your taxes on interest earnings until a future point in time. In the meantime you earn interest on the money you're not paying in taxes. You can accumulate more money over a shorter period of time, which ultimately will provide you with a greater income.

Many people today are choosing tax-deferred annuities as the foundation of their overall financial plan instead of certificates of deposit or savings accounts. Although CD's and annuities are very similar there are significant differences between the two. The most important difference is that annuities allow for the deferral of the taxes due on the interest earned until the interest is withdrawn! By postponing that tax with a tax deferred annuity, your money compounds faster because you can earn interest on dollars that would have otherwise been paid to the IRS. Later, if you decide to take a monthly income, your taxes can be less because they will be spread out over a period of years. Like CD's, annuities have a penalty for early surrender, however most annuity contracts have a liberal "free withdrawal" provision.

You pay NO taxes while your money is compounding. You can also pay a lower tax on random withdrawals because you control the tax year in which the withdrawals are made, and only pay taxes on the interest withdrawn. Tax deferral gives you control over an important expense - your taxes. Any time you control an expense, you can minimize it. The longer you can postpone this particular expense, the greater your gain when compared to the gain you would make with a fully taxable account.

To illustrate the increased earnings capacity of tax-deferred interest, compare it to fully-taxable earnings. $100,000 at 6.0% will earn $6,000 of interest in a year. A 30% tax bracket means that approximately $1,800 of those earnings will be lost in taxes, leaving only $4,200 to compound the next year. If these same earnings were tax-deferred, the full $6,000 would be available to earn even more interest. The longer you can postpone taxes, the greater the gain.

Your tax-deferred annuity is safe. A qualified legal reserve life insurance company is required to meet its contractual obligations to you. These reserves must, at all times, be equal to the withdrawal value of your annuity policy. In addition to reserves, state law also requires certain levels of capital and surplus to further increase policyholder protection. Legal reserve refers to the the strict financial requirements that must be met by an insurance company to protect the money paid in by all policyholders. These reserves must at all times be equal to the cash value (principal plus interest less early withdrawal fees, if any) of every annuity policy. State insurance laws also require that a life insurance company must maintain certain minimum levels of capital and surplus, which provide additional policyholder protection.

There is no withholding tax while your annuity is compounding; it is completely tax-deferred. If you request a distribution (random withdrawals or annuity income), taxes will be withheld - unless you elect differently. Your election not to withhold can be made at the time you make your request. Because the interest is tax-deferred, it is not necessary to issue a Form 1099 while your money is compounding. Only when your interest is distributed (withdrawal or annuity income) will a Form 1099 be sent, reflecting the amount of interest actually received.

An annuity policy does not "mature" like a bond or certificate of deposit. Both your principal and interest will automatically continue to earn interest until withdrawn or you reach age 100. You can let your money continue to grow, make withdrawals, or begin receiving an annuity income at any time.

An IRS penalty tax, currently 10%, may be payable on any withdrawal of interest or qualified premium made prior to age 59 1/2.

If a premature death should occur, the accumulating funds within your annuity may be transferred to your named beneficiaries, avoiding the expense, delay, frustration and publicity of the probate process. Like most assets, the annuity is part of your taxable estate. Your heirs can chose to receive a lump sum payment, or a guaranteed monthly income.