An annuity is a contract issued by an insurance company and usually
referred to as an annuity policy or annuity contract. What makes annuities
different is the tax treatment given them by the IRS.
Think of an annuity as an umbrella. When money is placed under the
umbrella or annuity contract, it is treated differently as far as taxes go.
- The money that you put in an annuity is referred to as
a premium, it's your original contribution or principal
contribution. Since you already have paid taxes on it, it never again will
be subject to taxation. This assumes that you haven't purchased an
annuity as part of a qualified retirement program such as an IRA,
401(k), TSA or 457 plan.
The money that you put into an annuity will earn interest or receive
dividend income or capital gain distributions. These "earnings", unlike
money in a savings account, mutual fund, certificate of deposit are not
taxed in the year in which they are earned. Thus the "earnings" will
continue to grow and compound tax free until withdrawn.
The IRS eventually collects taxes on the "earnings" of your annuity.
When you withdraw money from your annuity the earnings, according to
the IRS, are withdrawn first. The "earnings" are subject to "ordinary
income taxes" in they year in which they are withdrawn. Keep in mind that
capital gain distributions in a mutual fund are taxed at capital gains rates.
The IRS also has what it calls a "Premature Distributions". If you
withdraw your earnings and your under the age of 59 1/2. Not only are your
earnings tax at ordinary income tax rates, the IRS makes you pay a penalty
of an additional 10% on the earnings that are taxed.
However there are no penalties on distributions:
Made after your 59 1/2.
Made on or after the death of the owner of the annuity.
If the taxpayer becomes disabled.
A part of a series of substantially equal periodic payments (not less
than annually) for the life (or life expectancy) of the taxpayer or joints
lives (or joint expectancies) of the taxpayer and his or her designated beneficiary.
Made under a single premium immediate annuity with a starting date no
later than one year from the annuity purchase date.
Made under certain annuities issued in connection with a structured settlement agreements.
If a premature death should
occur, the accumulated funds within your annuity may be transferred to
your named beneficiaries, avoiding the expense, delay, frustration and
publicity of the probate process. Like most assets, the annuity is part of
your taxable estate. Your heirs can generally chose to receive a lump sum payment,
or a guaranteed monthly income.
Annuities Online does not give tax or legal advice. The comments regarding tax treatment
on this web site simply reflect our understanding of current interpretations of tax laws as they apply to annuities. Since tax laws
are always subject to interpretation and possible changes in the future. we recommend that you seek counsel of your attorney,
accountant or other qualified tax advisor regarding annuity taxation as it applies to your particular situation.