Top 5 Facts About Annuities And Taxes


There are often questions about annuities and taxes.  This brief guide will walk through a few of the top questions we receive.  Be sure to consult your own tax advisor for specific issues and clarifications.

Q: How Are Annuity Payments Taxed?

A: The basic rule for annuity taxation (i.e., “amounts received under an annuity”) is that the purchaser’s investment is returned in equal tax-free amounts over the payment period.  Tax is assessed on the earnings portion of each payment received. Each payment contains a portion that is return of principal and is nontaxable, and a portion of income, which is taxable income.

Q: How Is The Interest Income and Return Of Principal Portion Of A Payment Calculated?

A: For non-variable annuity contracts, this basic rule applies: Divide the purchase price by the total expected return.  This is called an “exclusion ratio”.  When you apply this exclusion ratio to each payment, you can determine the portion that is taxable, and the portion that is excluded from income.

For example, if you purchase a single lump sum future payment of $200,000, and pay $100,000 for it today,  exactly 50% of the future payment is taxable, and 50% is tax-free return of principal. The same calculation can be made for all period certain payments.

For  lifetime income payments, the IRS allows the use of your life expectancy age to determine the ‘end date’ of a payment stream for exclusion ratio purposes.

Q: If an annuitant dies before a deferred annuity matures or is annuitized into income, is the amount payable to heirs subject to income tax?

A: Yes. An annuity usually provides that the beneficiary will be paid the greater of the premium amount, or the accumulated value of the contract, as a death benefit in the event of the death of the primary annuitant. If there is gain, that gain is taxable as ordinary income to the beneficiary. Annuities are not like life insurance that qualify for tax free benefits to heirs.

That said, Secondary Market Annuities are absolute and certain payments, therefore in the event of the owners death, the payment stream will pass according to their will or estate plans.  The lump sum of un-returned principal will not be accelerated with Structured Settlement Annuities  and SMA’s.

Q: Are there penalties to “premature” distributions of  annuity contracts?

A: In order to discourage the use of annuities as short term tax sheltered investments, the IRS imposes a 10 percent tax on certain “premature” payments under annuity contracts.  This penalty applies to payments that are includable in income- see the exclusion ratio above. There are several exceptions however, the most common are:

(1) Payments made on or after the age of 59.5

(2) Payments made on or after the death of the annuity holder or annuitant,

(3) Payments accelerated to the annuitant if the annuitant has become disabled;

(4) Payments made in a lifetime, immediate annuity contract- there are certain IRS wrinkles here…

(5) There are other exceptions for certain annuities prior to 1982, other exceptions for dividends, and for a series of substantially equal periodic payments (SEPPs) made for the life of the taxpayer.

An important exception to note is that for qualified settlements and Structured Settlement Annuities such as our Secondary Market Annuities, there is NOT a penalty or extra tax assessed.  These are freely available to a buyer of any age.

Q: Are There Tax Implications For Partial Withdrawal and Lowered Annuitized Payments?

A: This may have a few answers depending on the annuitant.   But in general, a ‘free withdrawal’ from an annuity contract will be subject to the exclusion ratio, and once funds are withdrawn and the income payments are lower, the now-lowered remaining annuity payments will still be subject to the same exclusion ratio.

We hope this helps clarify a few questions about annuities and taxes,

Tax Bracket Magic… Forbes


This may be a little late but some of you may be looking for a few tax ideas at the last minute. If not then save this article for next year so you have a nice head start. Last week, Forbes published a very helpful piece that talks about several strategies that will help lighten your tax burden. And that’s good news for anyone who needs some easy ideas with that ever-more complicated tax code.

With the tax code constantly changing, everyone needs help to stay on top of the latest strategies. If you simply do the same thing every year you are essentially using the same strategy for a different game each time. In reality, many people do have fairly straightforward tax filings but for those of you who don’t, this article might offer some relief. Read Tax Bracket Magic here.

This article covers several of the changes that have taken place recently or are set to happen soon. With this information, there come a handful of suggestions as to how taxpayers can play the new game to their advantage. Whether you are talking about writing off stock losses, declaring dividend income or even sending kids to college there is likely something that just might deliver an added benefit for you.

Of course, let’s not forget the potential option for converting a retirement account to a Roth IRA. This is something that I have resisted for the most part but I am coming around to the idea. Conversion of assets can yield many more benefits in the form of flexibility on top of the possible future tax advantages. As with anything, this all depends on each individual situation.

So if you’ve considered any of the above options or are looking to get a leg up on the tax man next year, then this Forbes article is a must read. Please call or email if you have any comments or questions on this topic. Some if it we may have to defer to a tax expert but much of it falls squarely in the realm of retirement planning.

Have a great week!

Bryan J. Anderson
[email protected]