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]

No Time Like Now To Talk Taxes


How about we take slight break from Annuities this week and get down to something that affects every aspect of our financial lives.

From the Wall Street Journal comes this article titled “Smart Year-End Tax Moves.”

Since big changes to tax law are on the horizon, it may be a good idea to make sure you have time to act in case the changes could adversely affect your personal situation.

Yes, the debate on the extension of the Bush-Era tax cuts is at the center of this coming storm but everyone needs to understand that failure to stop the expiration will impact more than just the top income earners.

All income tax rates will rise without an extension and most concerning of all, the dividend tax rate will increase from 15% to 20%.  Now I’m certain that will have an effect on anyone currently saving for retirement.

Take a look at this worthwhile article and be sure you have time to make changes if needed.  As always, call or email with questions or comments and have a great week!

Bryan J. Anderson

800.438.5121 [email protected]

Annuity Vs CD| Are You Losing Money, Safely?


Certificates of Deposit or CDs are a great place to put money, right?  Well, the answer depends on if you are the bank or the customer.

As a customer you give the bank your money and agree to leave it there, at the risk of a penalty, for a certain period of time, usually anywhere from three months to five years.  In return, you are paid an interest rate that is better than a savings account or money market rate.

The bank takes your money and loans it out to other people at an even higher interest rate and makes a profit on the difference.  The bank makes more money but they also deserve to profit.  They guarantee your money and take the risk that a potential borrower doesn’t pay it back.  The bank’s reward is justified for the risk they take and the guarantee they offer depositors.

So far, it looks like a fair deal.  In simple form, each party should be happy with the terms.

But look beyond that relationship for a moment to see what else is going on outside that relationship.  Your money is safe, no doubt, but are you really getting ahead?…..

Most people don’t realize that money is susceptible to many eroding factors.  Among these, taxes and inflation are two of those factors I would like to focus on.  As we have explored in other areas of this site, taxes can seriously affect investment returns.  In just the same fashion, inflation can be every bit as damaging.

Let’s look at this by way of an example.   We’ll buy a CD, hold it for a year and adjust the earnings for taxes and inflation and see how much we have left.  Let’s start with $100,000.


4% CD interest rate

3% inflation

40% tax bracket

Initial Investment4% InterestLess 40% TaxPurchasing Power

Wow!  That is not an optical illusion.  In this scenario, after one year in a CD where inflation is a realistic 3%, the power of your money has actually decreased.

Now, in other areas of the site, we talk about protecting your money from taxes.  The inescapable truth is that inflation can make any investment look a lot less desirable.  If you want safety, you must find a place for cash that moves ahead of the rate of inflation.  Taxes make that job even more difficult.

As popular and safe as bank CDs are, the Straight Talk is that you are doing nothing more than losing money safely .