Final answer:
The taxable portion of an annuity payment is called the interest. This is calculated by dividing the investment in the annuity by the total expected payments. Understanding the taxation of investments like annuities and bonds is crucial for retirement planning.
Step-by-step explanation:
When determining the percentage of an annuity payment that is subject to tax, the portion that is subject to tax is known as the interest portion. The investment in the annuity is divided by the total of the expected payments to be received to figure out what fraction of each payment is a return of your principal (investment) and what fraction is interest. The principal portion is not taxed since it is a return of the investment in the contract, while the interest portion is taxable.
Saving for old age through private market options such as stocks, bonds, and annuities can be beneficial, especially if the investments have special tax status. For example, 401(k) accounts allow individuals to defer taxes until the funds are withdrawn, which can be a significant tax advantage. It is essential to understand how various investments, including bonds that carry interest and annuities that provide fixed sums, are taxed to effectively plan for retirement.