annuity taxation

Tax Consequences to the Annuity Beneficiary

Annuities are especially attractive to retirees because they assure an income for life. They’re often held as deferred annuities as a back up for those later retirement years as a supplement to other retirement income or when savings become depleted. But many retirees will die before tapping their deferred annuity. What are the tax consequences to the annuity beneficiary and should other options be arranged? A deferred annuity offers a distinct tax-benefit. It’s earning grow tax-deferred. For the same annual return as a taxable investment, a tax-deferred investment compounds faster because none of the earnings are taxed away each year. However those tax-deferred earnings will eventually be taxed upon withdrawal, whether by you or the annuity beneficiary. Your contributions to the annuity, though, will not be taxed. This is the case in ‘nonqualified’ annuities which are funded with after tax contributions. Annuitant’s taxation If a partial withdrawal is made, the IRS presumes that earnings come out first – so that these are completely taxable. But under regular monthly payments – a portion of each payment is not taxed but treated as a return of your nontaxable contributions. An exclusion ratio calculated by the insurance company designates that untaxed portion. When, [...]

Annuity Taxes of a Fixed Immediate Annuity

Fixed Immediate annuities can provide a steady income for a specified period of time that may even surpass your natural life. How long you choose to take these payments can depend on your present and future income needs, as well as your survivors’ requirements. But there is one more point that you may want to look at when reviewing the various payout options available, and that is the annuity tax implications to you and your beneficiaries. A portion of the money you would receive each year is a tax-free return of your investment. The balance is taxable, and those amounts can vary among the different payment periods. For instance, suppose that you are a 65-year old male, the IRS gives you a life expectancy of 20 years, and you are offered the following choices for a $250,000 investment: • A life only payout ceases when you die and will give you approximately $20,000 per year. Of this amount, $12,500 (1/20th of $250,000) would be tax-free and the balance ($7,500) taxable. If you live longer than 20 years, all $20,000 will be taxable. • A life with 20-year certain pays for 20 years or your lifetime, whichever is longer. You would [...]

Annuities Require Careful Tax Planning

One popular benefit of a fixed annuity is that you can let the interest in the account compound each year without paying income taxes. This allows your money to possibly grow faster as compared to fully taxable investments that pay similar, before-tax returns. When you start making withdrawals, the percentage of income that is taxable depends on how you structure the distributions. Your beneficiaries, however, may not have that flexibility, and could face a big annuity tax bill on the inheritance. Assuming your annuity is not held in a tax-qualified account, such as an IRA, your heirs will have to pay income tax on the built-up earnings when you die. Suppose that you put $250,000 into a fixed annuity a number of years ago, and now it is worth $450,000. If you died today, your beneficiaries would receive the $450,000, and would have to pay as much $70,000 in federal income taxes on the accumulated profit (maximum federal income tax rates are currently 35%). To help your heirs keep the money you earned, you may want to consider purchasing a life insurance policy for the amount of the estimated tax bill. You could pay the premiums yourself, ask your beneficiaries [...]