Annuities - Tax

An annuity basically is a contract between you, and an insurance company that is designed to meet certain types of retirement and other long-range goals, under which you make a lump-sum payment or series of payments. In return, the insurer agrees to make periodic payments to you beginning immediately or at some future date.

Annuities typically offer tax-deferred growth of earnings and may include a death benefit that will pay your beneficiary a specified minimum amount, such as your total purchase payments. 

While tax is deferred on earnings growth, when withdrawals are taken from the annuity, gains are taxed at ordinary income rates, and not capital gains rates. If you withdraw your money early from an annuity, you may pay taxes, or penalties depending on age, time, each plan is different, so be sure to evaluate your options.

How Are Annuities Taxed?

One of the most attractive features of an annuity is its tax-deferred status. Generally, you won’t pay any income tax on the interest or earnings until you start taking withdrawals in retirement (age 59½ or later).

Qualified and nonqualified annuities are taxed differently. Qualified annuities (such as annuities in an employer-sponsored retirement plan or an IRA) are typically purchased with pre-tax money, so withdrawals are fully taxed as ordinary income.

It’s important to understand that purchasing an annuity in an IRA or an employer plan provides no additional tax benefits than those available through the original tax-deferred retirement plan.

Annuities purchased with after-tax money are taxable upon withdrawal, but only the earnings are taxed. Nonqualified annuities bought after August 13, 1982, are taxed on a Last In, First Out (LIFO) basis. This means that as you take withdrawals, the accrued interest will be the first money taken out and taxed as ordinary income. 

After the interest has been paid, the initial investment amount will then be distributed without any further taxes. Annuities can have surrender charges that are assessed during the early years of the contract if the contract owner surrenders the annuity, check your options.

In addition, if the contract is surrendered before age 59½, you may be subject to a 10% federal income tax penalty.

Are Annuities Great for your Portfolio?

Different types of annuity are particularly suitable for different categories of investors, depending on the investor’s preferences. Traditional fixed annuities are suitable for the most conservative class of investor, anxious to avoid any loss of principal and willing to accept a rate of return commensurate with that on government bonds or high-grade corporate securities. Indexed annuities offer a slightly higher rate of return but still offer numerous safeguards to principal, in exchange for more volatility of annual returns. Variable annuities offer rates of return comparable to those earned by mutual funds, but variable offers risk/return options.

The spectrum of annuity types includes something for every Individual category, conservative, aggressive or in-between and depending on each Individuals specific needs or goals will determine which Annuity becomes the perfect match or fit within one's portfolio. So the answer becomes "yes" Annuities are great options, if properly structured by your requirements on needs.

If you are considering Retirement Planning, call for a free consultation today.