Split Annuity Taxation

2 Jan

An investment’s return is what most people analyze each year. However, what really counts is how much you hold on to after taxes. After all, that’s what you get to spend. If you’re shopping around for CDs, you may want to look at an alternative idea that will let you keep more of what you earn.

Suppose that you are considering a five-year jumbo CD. The certificate’s earnings may push your provisional income over the government’s threshold (provisional income is the income calculated by IRS to determine if and how much of your Social Security income becomes taxable). The result is that more of your Social Security check will become taxable when you add interest from CDs.

The solution could be an immediate annuity that will pay you an income for five years (five-year certain). Part of that income will be taxable, while the rest considered a tax-free return of your investment. At the end of five years, the payments stop. To replace the funds you put into the immediate annuity, you would invest in a five-year fixed annuity. Interest earnings on the fixed annuity are tax-deferred, and not counted towards the government’s threshold of taxation of Social Security income.

The result is that you would have one investment that is partially taxable and another that is tax-deferred, therefore your provisional income should go down. With the right planning, you may possibly reduce it to the point that you would not have to pay income taxes on any of your Social Security benefits. Additionally, a decline in your adjusted gross income will lower the floor on medical expense deductions, and miscellaneous itemized deductions.

When the five years are up, you could remove funds from the fixed annuity, pay the income annuity tax, and purchase another immediate annuity. Or you could annuitize the fixed annuity for lifetime payments.
Much of this strategy depends on your current tax bracket, itemized deductions, exemptions, and income requirements. Therefore, in order to make sure this is an appropriate solution for you, we would need to include these factors in your analysis.

Ask your retirement advisor to give you an analysis of a split annuity.

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