[vc_row][vc_column width=”2/3″ el_class=”section section1″][vc_column_text]An annuity offers you income that is always guaranteed for as long as you live. Such retirement savings vehicles do not offer any sort of tax benefits by allowing earnings to grow tax-deferred. Small parts of your annuity payments are subject to federal income taxes. Allow us to highlight various ways annuities are taxed by the IRS.
Initial Tax Considerations for Annuities
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There are different types of annuities, such as indexed or variable, and varying situations that impact tax liability. Also, tax laws and rates change frequently, and you cannot possibly be sure about when you will start to take withdrawals, so you cannot know for sure what the situation will be when it comes to taking money out of your annuity. Nonetheless, you can proceed to make some educated guesses in regards to common scenarios.
Qualified or Non-Qualified
Again, the key factor to determine how the IRS is going to tax your annuity is based on where you received the money to buy it. From the viewpoint of the government, this determines if your annuity is either qualified or non-qualified for tax purposes.
A qualified annuity is one that you bought with money that you had not paid taxes. For example, if the premiums used to pay for an annuity originated from a tax-deferred retirement account like a traditional 401(k) or traditional IRA, it will be a qualified annuity. You will be required to pay normal income taxes on any future annuity payments that are qualified. It is important to understand that annuity payment is counted as ordinary income. Generally speaking, this is not a favorable capital gains rate.
A non-qualified annuity is one that you bought with money that you have already paid the taxes on. For instance, if you write a check from your taxable bank or a brokerage account to paying a premium for the annuity, it is considered a non-qualified annuity. The IRS refers to it as the post-tax purchase money. Individuals that have a non-qualified annuity will not have to pay taxes twice on the money that was used to purchase it. However, you may owe taxes on interests and earnings that have been growing to tax-deferred in the annuity.
Period or Lifetime
The type of annuity that you have will also impact your tax liability in the future. Many different subsections include fixed, variable, immediate and deferred annuities. For this, only period and lifetime annuities will be highlighted.
The guaranteed regular amount is paid in a lifetime annuity; this is usually per month for as long as you live. A period annuity is one that offers you regular payments for a given number of years.
Based on period annuities, you will simply multiply the number of payments by the payment amounts. Thus, if you have a 10-year annuity that will be paying you $12,000, a return of 10 times should be expected, which amounts to $120,000.
Individuals with a lifetime annuity face a slightly complicated matter when calculating their expected return. To figure out your tax liability with a lifetime annuity, first you must estimate your life expectancy, followed by the number of years you are expecting to receive payments, based on the size of the annual payments.
For instance, let’s say you have a lifetime annuity that is paying you $12,000 per year. You are at age 65, and based on the IRS longevity table, you will be expected to live to 85, which is another 20 years. In turn, through multiplying the 20 years and $12,000, you will receive $240,000 as your expected return.
Annuity Taxes Put into Practice
Based on the post-tax purchase money for annuities that are non-qualified, you can take that basis and divide it by the expected return. The result of the equation is the percent by the amount of each payment that is not going to be taxable. To ensure things are more tangible, you should multiply the percentage with the amount of every payment to figure out the exact amount won’t be subject to federal income taxes.
For instance, let’s say you paid for a lifetime annuity that is $90,000 and has an expected return of $120,000. By dividing $90,000, which is the basis by the expected return of $120,000, it gives you 75%. Then, through multiplying 75% with the amount of every payment, you will be able to see the amount of the payment that won’t incur taxes. Therefore, if the $120,000 annuity assumes that you have a life expectancy of 20 years, the monthly payments would come to $400. From that amount, $300 (or 75%), would be tax-free.
This is merely a simple example of what you may encounter in real life. Various situations might be subject to higher or less taxation. If you live longer compared to the longevity table of the IRS, you could be taxed on all of your lifetime annuity payments that take place after you have reached the IRS longevity table forecasted maximum age. It is a good idea to consult with a financial advisor. Tax professionals, in particular, can assist you before you decide to buy or take withdrawals from the annuity.
If you feel that you have exhausted all your options for boosting your retirement savings, it is advisable to consult a financial advisor that specializes in retirement planning in the past.[/vc_column_text][/vc_column][vc_column width=”1/3″][vc_single_image image=”19729″ img_size=”292×285″ style=”vc_box_shadow”][/vc_column][/vc_row]
