Tax laws act like a "carrot and stick" to encourage you to keep your money in your account until you reach retirement age.

The tax advantages of deferred annuities are intended to help you build assets for retirement. If you use your annuity as intended, you'll receive the tax benefits and avoid the penalties. Consult a tax adviser for advice on your specific circumstances.

Tax-deferred growth
A tax-deferred investment can help your money grow faster than a taxable investment earning a similar return. You pay no taxes on annuity earnings until you withdraw your money. This means that all your money keeps working for you without being reduced by annual taxation.

Move money tax free
Variable annuities allow you the flexibility to transfer money between investment options without losing any of your savings to taxes. This makes it easier to take profits and readjust strategies when needed.

Simplify tax reporting
Since taxes on all earnings, including dividends, interest, and capital gains are deferred, there are no annual tax reporting requirements until withdrawals begin.

Tax penalty
If you withdraw earnings before age 59½, you may be subject to a 10% federal income tax penalty.

Only earnings are taxed
During the accumulation phase, your withdrawals are treated as "earnings out first." Any earnings from an annuity are taxed as ordinary income in your tax bracket, not as capital gains. Only earnings are taxed because the money you invested was taxed when you earned it.

No required distributions
Traditional IRAs and 401(k) plans require you to begin taking money by age 70½. Depending on your annuity, you may have much longer to begin, possibly until age 90 or beyond. This means your money can continue to grow tax deferred over a longer time.

Tax-efficient annuity payments-the exclusion ratio
Annuitized income payments are taxed according to a concept known as the exclusion ratio. Part of each payment is considered a return of principal, assumed to have been taxed before purchase, and is therefore not taxed. The remaining portion is considered earnings and is taxable.

By contrast, a systematic withdrawal plan during the accumulation phase, is taxed according to the concept of "earnings out first," which regards withdrawals as taxable earnings until the account value is reduced to the total of purchase payments, less any withdrawals and similar adjustments.

Taxes on lump-sum payments
If you take money in a lump sum, you'll pay income tax on the part you've earned. Depending upon your earnings, your tax liability could be substantial. As explained above, a lump-sum withdrawal prior to age 59½ may also be subject to a 10% federal income tax penalty.

Annuities within other retirement plans
Some annuities can be funded with pretax money, such as those that are held within a 401(k) or traditional IRA. These annuities are called qualified annuities, and may require you to take money at age 70½. The fixed and variable annuities discussed in this guide are funded with after-tax money and are known as nonqualified annuities.

Your tax adviser
Ask about premium taxes for your state, or if you plan to:

• Move your money from one annuity to another-ask about a 1035 Exchange to protect your money from the loss of certain tax advantages. This type of exchange may also result in surrender charges imposed by the issuing company.
• Buy more than one annuity-ask about aggregation.
• Give a family member an annuity-ask about gift and income tax consequences.
• Buy an annuity for a trust, corporation, or partnership-ask about Internal Revenue Code Section 72(u).