Annuity123 is dedicated to providing Americans with unbiased information about retirement, answering the tough questions you want to know.

With hundreds of articles on every retirement planning topic you can think of, peace of mind is just a click away.

How Are Annuities Taxed?

Stan The Annuity Man

Question: How are annuities taxed? from Darrell in Phoenix, AZ

Answer: That’s a pretty broad question Darrell, but and extremely important one.  Let me get right to the point when it comes to annuities and taxes.  Always use a CPA or qualified tax professional for any type of tax questions that are related to annuities.  Never take an agent’s word for it.  I probably know more about annuities and taxes than most (heck, I’m Stan The Annuity Man!), but even I defer all questions to the tax pros.  I’m an annuity pro, not a tax pro.  With that being said, and with the hope that you fully understand that a tax pro will have to eventually sign off on any tax recommendation, let’s look at some broad tax issues concerning annuities.

Death Benefits

Even though annuities are classified as life insurance products, annuity death benefits are not taxed the same as life insurance.  The death benefit proceeds from a life insurance policy are free from taxes, and also avoid probate.  Death benefits from annuities do NOT pass tax free to the beneficiaries.

Income from Annuities

Annuity income is taxed at ordinary income levels, and from a LIFO (Last In First Out) accounting method.  In English, that means that the gains come out first, and you are taxed on those gains first.  Just like money taken from your IRA is taxed at ordinary income levels, so is any income stream from annuities.

If an income stream is “annuitized”, than means the income is generated from a combination of a return of principal and interest.  If the income is not coming from an IRA, then there is an “exclusion ratio” involved.  Exclusion ratio simply means that you will not pay taxes on the return of principal (makes common sense), just the interest part of the income.  Annuitized income coming from an IRA has no exclusion ratio, and the entire income stream is taxable at ordinary income levels.

Free Withdrawals from Annuities

Most deferred annuities allow you to take 10% per year (penalty free) from your annuity from a liquidity standpoint.  Any money withdrawn from an annuity is brought out “gains first”, or LIFO.  Understand that you will pay taxes at ordinary income levels on all of the gains (if any) before you start dipping into the principal.  Once the gains are depleted, and you start withdrawing principal, there will be no taxes on that original principal amount.

There are books written on the subject of annuities and taxes.  My favorite is written by John Olsen, called “Taxation and Suitability of Annuities.”  He covers all of the bases of annuity taxes with trusts, estate planning, etc., and it really should be required reading for all agents as a foundation of knowledge only…..and not license to give tax advice in any circumstance.

The bottom line is that with anything tax related concerning annuities, it can get complicated…..and you cannot afford to make mistakes with our “friends” at the IRS.  Don’t let an annuity agent tell you otherwise, and don’t depend solely on an agent for tax advice.  Always use a tax professional.

*If you have a question for Stan The Annuity Man, please send your question to stan@stantheannuityman.com.  He will answer all questions directly, and might include yours in his next Annuity123 “Ask Stan The Annuity Man” blog every Thursday.

Click here to see more educational articles from Stan The Annuity Man.

About the Author:

Stan The Annuity Man is a nationally recognized annuity expert and annuity critic, and has been called the national consumer advocate for annuities… and a walking middle finger of annuity truth.  He is a weekly RetireMentor columnist for The Wall Street Journal’s MarketWatch.com, and is the exclusive annuity contributor for About.com.  His highly acclaimed book, The Annuity Stanifesto, is a top seller in its category, and is known as the go to resource for all things annuity.

Stan The Annuity Man has clients nationwide, and is considered one of the top independent annuity agents in the country.  You can learn more at www.StanTheAnnuityMan.com.

 

Annuity123 does not offer insurance, investment, or tax advice.  You should always seek the guidance of qualified and licensed professionals concerning your personal insurance, investment, or tax matters.  Annuity123 is simply a platform allowing retirement planning professionals to help educate the community on various retirement planning topics.  Annuity123 does not directly support or take responsibility for ensuring the accuracy of the content displayed in the articles themselves or any feedback that may get added in the Comments section from the community.

1 Comment

  • John Olsen says:

    Stan, Nice job! I would add a couple of caveats. If you want the owner and annuitant to be different parties (and that's usually a bad idea), confirm is your deferred annuity is "annuitant-driven". If so, you may be surprised at "whose death triggers which death benefit". Also, don't name a trust as owner OR beneficiary of your deferred annuity unless you KNOW the tax implications and are happy with them.

Leave a Reply

Your email address will not be published.