An annuity is an insurance product that pays out guaranteed income and can be used as part of a retirement strategy. The income you receive from an annuity can come monthly, quarterly, annually, or even in a lump sum payment. But what about Uncle Sam’s request for taxes on that money?
In general, the amount you contributed to the annuity isn't taxed, but your earnings are taxed at your regular income tax rate. You fund a qualified annuity with pre-tax dollars, and a non-qualified annuity is funded with post-tax dollars. This impacts the tax treatment of your payouts; allowing you to save by investing and deferring tax payments.
For example, if you deposited $40k into a non-qualified annuity and the account grows to $100k, you will only be taxed on the $60k earnings/interest. Since the earnings are distributed first, taxes are paid upfront until you draw back down to the principal deposit.
Qualified annuities are subject to Required Minimum Distribution (RMD) guidelines. You must begin taking distributions from a qualified annuity by April 1 of the year after you turn 72.
Non-qualified annuities are exempt from RMDs. Once you start taking distributions from a non-qualified annuity, any interest or earnings within the annuity will be distributed before the premium or principal amount.
With fixed-rate annuities, you’re not responsible for determining where your money goes - the insurance company handles that job and agrees to pay you a pre-determined fixed return. With a variable annuity, you decide where to put your money in the sub-accounts (essentially mutual funds) offered within the annuity. The value of your account depends on the performance of the funds you choose.2
Unlike other tax-deferred retirement accounts such as 401(k)s and IRAs, there typically isn't an annual contribution limit for an annuity. That could allow you to put away more money for retirement and the money you put into the annuity compounds year after year without any tax bill from Uncle Sam. That ability to keep every dollar invested working for you can be a significant advantage over taxable investments.
There are rules and fees that come with an annuity, so it’s important to talk with a financial professional before adding this to your portfolio. Also, it’s important to keep in mind that if you make a withdrawal before the designated time period (typically five to seven years), you can expect to pay early withdrawal penalties on your annuity. There's a lot to know and understand with annuities, more than can be covered in this article such as variable payouts and potential guaranteed income, so it's best to have a discussion with a professional before making any decisions.
If you’re concerned about how taxes will affect your retirement income, or you’re interested in an annuity’s tax-free growth potential, give our office a call today. We’d like the opportunity to answer your questions.
This document is for educational purposes only and should not be construed as legal or tax advice. One should consult a legal or tax professional regarding their own personal situation. Any comments regarding safe and secure investments and guaranteed income streams refer only to fixed insurance products offered by an insurance company. They do not refer in any way to securities or investment advisory products Insurance policy applications are vetted through an underwriting process set forth by the issuing insurance company. Some applications may not be accepted based upon adverse underwriting results. Death benefit payouts are based upon the claims paying ability of the issuing insurance company. The firm providing this document is not affiliated with the Social Security Administration or any other government entity.
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1 https://www.ameriprise.com/financial-goals-priorities/taxes/how-are-annuities-taxed
2 https://money.cnn.com/retirement/guide/annuities_basics.moneymag/index10.htm?iid=EL