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A personal tax advisor should always be consulted, as insurance agents are not trained or qualified to provide tax advice.
All interest withdrawn before the owner attains the age of 59½ is subject to a 10 percent excise tax penalty. However, the 10 percent excise penalty can be avoided under certain circumstances.
Withdrawals of interest before age 59½ may be subject to a 10% excise tax penalty. Certain exceptions may apply, including disability, death, immediate annuity payments, structured settlements, and substantially equal payments.
When the owner annuitizes the contract, an exclusion ratio may apply. This means a percentage of each payment may be considered a return of the owner’s cost basis and may be tax-free, while the balance is taxable.
Section 1035(a) of the Internal Revenue Code provides the ability to transfer money from one annuity to another annuity income tax-free. These transfers should be reviewed carefully with a tax advisor.
The 10 percent excise penalty can be avoided under certain circumstances, including:
The annuitant will receive equal payments when and if the owner annuitizes, meaning the owner applies the annuity value toward a settlement option.
Unlike withdrawals, the contract owner does not pay full taxes on the payments. An exclusion ratio is applied to each payment received, which stipulates that a percentage of each payment is considered a return of the owner’s cost basis and is tax-free. The balance, however, is taxable.
The exclusion ratio can be calculated by dividing the expected return into the total of all premiums paid into the contract.
Effective with all annuities starting dates after 12/31/86, payments become fully taxable after the owner recovers the total of all premiums paid into a contract. This is determined by adding all dollars excluded from taxes.
After the contract owner has lived beyond his or her life expectancy, as calculated when payments began, payments then become fully taxable.
Depending upon the annuity purchased, withdrawals can be taxed in one of two ways.
Before 8/14/82, annuities were structured with FIFO accounting, meaning first in, first out. This allowed the principal to remain tax-free.
On 8/14/82 and after, annuity taxation changed to LIFO, meaning last in, first out. This allows for taxation on withdrawals since interest is withdrawn early.
This can be appealing to customers since most are now paying taxes on interest even if they do not withdraw it.
Section 1035(a) of the Internal Revenue Code provides the ability to transfer money from one annuity to another annuity income tax-free. Such transfers should be reviewed carefully.
The contract owner may elect to perform any of the following:
For more information about annuity taxation, please contact Healthcare American today.
No. A personal tax advisor should always be consulted. Insurance agents may explain basic annuity taxation concepts, but they are not trained or qualified to provide tax advice.
The 10% excise tax penalty can apply when interest is withdrawn before the owner reaches age 59½, unless an exception applies.
Exceptions may include disability, death, certain immediate annuity payments, structured settlements, pre-8/14/82 annuity distributions, and substantially equal payments over life expectancy.
The exclusion ratio determines the percentage of each annuity payment treated as a return of cost basis and therefore tax-free, while the remaining portion is taxable.
FIFO means first in, first out. Before 8/14/82, annuities were structured with FIFO accounting, which allowed principal to remain tax-free when withdrawn first.
LIFO means last in, first out. For annuities issued on or after 8/14/82, interest is generally treated as withdrawn first and taxed before principal.
A Section 1035(a) exchange allows money to be transferred from one annuity to another annuity income tax-free, subject to rules and careful review.
Yes. Customers should consult with their tax advisors before completing a 1035 exchange or making decisions involving annuity taxation.
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