As I talk with seniors from across the nation, it’s obvious they loathe paying taxes. Financial salespeople often play on this dislike of paying taxes to motivate seniors into buying a high-commission investment even though it will earn the senior less in the long run. The only one earning more in this situation is the salesperson!

There are two basic kinds of tax-advantaged investments—tax-free and tax-deferred. The two are often confused even though they are very different. For instance, municipal bonds are tax-free. You don’t have to pay any Federal income tax on the interest that you earn on a municipal bond—ever. This allows municipalities to borrow money for public works projects at lower interest rates, saving the public money.

The simple way to calculate whether you are better buying a tax-free municipal bond versus a taxable bond is to divide the tax-free yield by 1 minus your tax rate. For instance, if you are in the 28% tax bracket and a 10-year municipal bond is yielding 3.78% then you divide 3.78 by .72, which equals 5.25%. That means that you would have to earn over 5.25% on a taxable bond to give you more after tax income then the municipal bond.

Tax-deferred investments work quite differently. Annuities are the most often used tax-deferred investment. You don’t avoid paying income tax in a tax-deferred investment. You only delay paying taxes, which are due when money is taken out of the tax-deferred vehicle. If you don’t plan on using the money yourself, the taxes will still have to be paid at your death.

Not only will you have to pay taxes on tax-deferred investments in the future, it is likely that you will have to pay more in taxes then compared to paying the tax now for two reasons.

First, any earnings on a tax-deferred vehicle will be taxed at ordinary income rates—for instance the 28% we assumed earlier. If you invested that money in an investment that paid dividends and/or capital gains and paid the taxes now, you would only have to pay taxes at the 10% or 15% level.

That’s a huge difference. In our example, earnings taken out of an annuity will be taxed at 28%. Dividends and capital gains off of a mutual fund will be taxed at 15%. That’s a 13% difference!

Financial salespeople will use the fear of paying taxes in an attempt to convince a 70 or 80 year old that they should buy an annuity. That is completely bogus! Studies have shown that your money must be left in an annuity for 20-30 years before you begin to see the benefits of tax-deferral. Again, the only one benefiting from the transaction is the salesperson. Don’t fall for this trap.

Another trick that financial salespeople will use to sell an annuity is to say that it will keep your Social Security from being taxed. That’s true, but if you use an annuity you’ll push all those taxes down the road. Later on, that could force you (or your heirs if you’re deceased) into a higher tax bracket and you’d end up paying more.

Here’s the bottom line. If you’re in a tax bracket of 27% or higher then use tax-free municipal bonds for the income portion of your portfolio. For the equity portion of your portfolio, use tax-efficient vehicles like Exchange-Traded Funds where you can control the timing of the tax event while having the dividends and capital gains taxed at much lower rates.

As you can see, there isn’t a single case in my opinion where an older investor will benefit from a tax-deferred annuity. With current tax rates it just doesn’t make dollars and sense. Be smart, do the simple math, and you’ll come out ahead.

Nationally-syndicated financial columnist and Certified Financial Planner® Jeffrey Voudrie provides personal, in-depth money management services and advice to select private clients throughout the USA. He’ll answer your financial question – FREE at http://www.guardingyourwealth.com

Got questions? Go to http://www.guardingyourwealth.com and click on ‘Ask Jeff’. I’ll be glad to personally give you an unbiased opinion. Visit our web site to read previously submitted questions and answers.

In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie serves clients nationwide using a proprietary money management system he's personally developed.