Annuities and dividend-paying stocks work differently when it comes to income, taxes and risk. Annuities offer fixed or variable payments under a contract, often used for retirement. Dividend stocks pay income from company profits and may also grow in value. Which one works better depends on your needs for taxes, flexibility and risk.
Annuities vs. Dividends Stocks: What’s the Difference?
Annuities are contracts with insurance companies that offer income either immediately or at a future date. The payments can be fixed or fluctuate based on market performance. For example, someone nearing retirement might purchase a $250,000 fixed annuity that guarantees $1,200 per month for life, regardless of market changes. This creates predictable income but usually ties up the initial investment.
Dividend stocks represent ownership shares in companies that return part of their earnings to shareholders. These payments vary depending on the company’s profits and policies. Suppose an investor buys $250,000 worth of dividend-paying stocks yielding 4% annually. That could generate $10,000 per year, but payments might rise, fall or stop if company performance changes. Dividend stock itself could appreciate or lose value. Investors have the flexibility to sell or buy more shares at any time without restrictions or added costs.
While annuities prioritize stability and guaranteed income, dividend stocks offer growth potential and more flexibility. Investors seeking income need to weigh whether they prefer contractual certainty or the potential for increasing returns with market exposure.
How Are Annuities and Dividend Stocks Taxed?
Annuities are tax-deferred, meaning earnings aren’t taxed until withdrawn. Withdrawals are taxed as ordinary income, not at capital gains rates. For example, if someone invests $100,000 in a deferred annuity that grows to $160,000 and later withdraws $30,000, that entire $30,000 may be taxed as regular income, depending on the contract structure and whether it’s a qualified or non-qualified annuity.
2025 Ordinary Income Tax Rates
| Tax Rate | Single Filers | Married Filing Jointly | Married Filing Separately | Head of Household |
|---|---|---|---|---|
| 10% | $0 – $11,925 | $0 – $23,850 | $0 – $11,925 | $0 – $17,000 |
| 12% | $11,925 – $48,475 | $23,850 – $96,950 | $11,925 – $48,475 | $17,000 – $64,850 |
| 22% | $48,475 – $103,350 | $96,950 – $206,700 | $48,475 – $103,350 | $64,850 – $103,350 |
| 24% | $103,350 – $197,300 | $206,700 – $394,600 | $103,350 – $197,300 | $103,350 – $197,300 |
| 32% | $197,300 – $250,525 | $394,600 – $501,050 | $197,300 – $250,525 | $197,300 – $250,500 |
| 35% | $250,526 – $626,350 | $501,050 – $751,600 | $250,525 – $375,800 | $250,500 – $626,350 |
| 37% | Over $626,350 | Over $751,600 | Over $375,800 | Over $626,350 |
Dividend stocks are taxed in the year dividends are received. Qualified dividends are typically taxed at the long-term capital gains rate—0%, 15% or 20%—based on income level. Suppose an investor earns $6,000 in qualified dividends and falls in the 15% bracket; they’d owe $900 in federal taxes that year. Non-qualified dividends, by contrast, are taxed as ordinary income.
2025 Long-Term Capital Gains Tax Rates
| Filing Status | 0% Rate | 15% Rate | 20% Rate |
|---|---|---|---|
| Single | Up to $48,350 | $48,351 – $533,400 | Over $533,400 |
| Married Filing Jointly | Up to $96,700 | $96,701 – $600,050 | Over $600,050 |
| Married Filing Separately | Up to $48,350 | $48,351 – $300,000 | Over $300,000 |
| Head of Household | Up to $64,750 | $64,751 – $566,700 | Over $566,700 |
The timing and rate of taxation differ significantly, influencing after-tax income. Annuities delay the tax hit but may lead to higher rates upon withdrawal. Dividend stocks generate current income with potentially lower tax rates.
Pros and Cons of Annuities
Annuities can offer stability and predictability, but they also come with trade-offs in terms of cost, flexibility and complexity. While they appeal to those seeking reliable income, they may not suit investors who prioritize growth or liquidity.
Pros:
- Guaranteed income: Annuities can provide a steady income stream, which can be especially beneficial during retirement.
- Tax-deferred growth: Earnings on annuities grow tax-deferred until withdrawals begin, potentially allowing for more significant accumulation over time.
- Customization: Various riders and options can tailor annuities to individual needs, such as inflation protection or death benefits.
- Longevity protection: Certain annuities offer payments for life, helping to mitigate the risk of outliving one’s savings.
Cons:
- Fees and expenses: Annuities often come with higher fees compared to other investment products, which can erode returns.
- Liquidity constraints: Withdrawing funds early may incur surrender charges and tax penalties. Once cash is placed in an annuity, access to it is limited.
- Complexity: The variety of annuity products and features can be confusing, making it challenging to understand the terms fully.
- Inflation risk: Unless adjusted for inflation, fixed payments may lose purchasing power over time.
Pros and Cons of Dividend Stocks
Dividend stocks can provide a blend of income and long-term growth, but they also come with market risk and income uncertainty. Investors may find them attractive for building wealth over time, though returns are not guaranteed and can fluctuate with company performance.
Pros:
- Income generation: Dividend stocks provide regular payouts that can supplement other income sources.
- Growth potential: In addition to dividends, the stock itself may appreciate in value over time.
- Tax advantages: Qualified dividends are typically taxed at lower capital gains rates, depending on income.
- Liquidity: Stocks can generally be bought and sold easily through brokerage accounts, offering convenience and flexibility.
Cons
- Market volatility: Stock prices fluctuate, and dividend-paying companies are not immune to downturns.
- Dividend cuts: Companies can reduce or eliminate dividends at any time, especially in poor economic conditions.
- Concentration risk: Relying heavily on dividend stocks may limit exposure to other asset classes.
- No guaranteed return: Unlike annuities, dividends and stock performance are not contractually guaranteed.
Annuities vs. Dividend Stocks: Which Should You Invest in?
Annuities may appeal to those seeking predictable cash flow and protection from longevity risk, especially in retirement. They shift investment risk to the insurer but often limit upside potential and flexibility.
Dividend stocks, on the other hand, suit investors who can tolerate market fluctuations and are looking for income with growth potential. They offer more liquidity and the possibility of rising dividends, but without any guarantees. They are also far less complex, so it’s much easier to understand what you are putting your money into. Some investors may benefit from combining both—using annuities for baseline income and dividend stocks for supplemental growth.
Bottom Line
Whether you pick an annuity or a dividend stock will depend on whether you prefer a fixed structure or more flexibility. Annuities offer predictable payouts but less control, while dividend stocks allow for growth and income with more market risk. Using both can balance steady income with long-term growth.
Investment Planning Tips
- A financial advisor can help you pick investments and manage risk for your portfolio. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you want to know how much you could pay in taxes for the sale on an investment, SmartAsset’s capital gains calculator can help you get an estimate.
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