Taxation of Annuities During the Accumulation Period

Taxation of Annuities During the Accumulation Period

Income earned by a variable annuity (see Questions and Answers below) is not taxed during the accumulation period. No tax will be payable until the earlier of: (a) the surrender of the contract; (b) a withdrawal from the contract; or (c) the time payments under the annuity begin (annuitization). To obtain annuity treatment, however, the underlying investments of the segregated asset account must be adequately diversified according to IRS regulations. Payments made as an annuity…

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Taxation of Annuity Distributions during the Payout Period

Taxation of Annuity Distributions during the Payout Period

Annuitants’ investment in an annuity is returned in equal tax-free (return of capital) amounts during the payout phase. Any additional amount received is taxed at ordinary income rates. This means each payment consists of two parts: the first part is considered return of capital and is therefore nontaxable, while the second part of each payment is considered return on capital (income) and is therefore, taxable at ordinary rates. The amount of each period’s payment that…

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8 Circumstances When Penalties on Premature Annuity Distributions Will Not be Invoked

8 Circumstances When Penalties on Premature Annuity Distributions Will Not be Invoked

Premature distributions (those made before certain dates listed below) are subject not only to the normal tax on ordinary income but also to a penalty tax of 10 percent. The 10 percent penalty applies only to the amount of the distribution that is included in income. The penalty for premature distributions will not apply to any of the following: payments that are part of a series of substantially equal periodic payments made for the life…

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When Withdrawals on an Annuity are Made Prior to the Annuity Starting Date

When Withdrawals on an Annuity are Made Prior to the Annuity Starting Date

Owners of annuities often take dividends, make cash withdrawals, or take other amounts out of their annuity contracts before the annuity starting dates. Such amounts are taxable as income to the extent that the policy cash value exceeds the investment in the contract—this results in a Last In, First Out (LIFO) type of treatment where all interest/growth is taxed before any tax-free return of capital payments can occur. This interest first rule was imposed to…

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Tax-Free Buildup within Annuities is Available Only to Natural Persons, not to Corporations

Tax-Free Buildup within Annuities is Available Only to Natural Persons, not to Corporations

Income earned by a variable annuity is not taxed during the accumulation period. No tax will be payable until the earlier of: (a) the surrender of the contract; (b) a withdrawal from the contract; or (c) the time payments under the annuity begin (annuitization). To obtain annuity treatment, however, the underlying investments of the segregated asset account must be adequately diversified according to IRS regulations. Payments made as an annuity under a variable annuity are…

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A Brief Primer on the Taxation of Annuities

A Brief Primer on the Taxation of Annuities

The taxation of annuities is governed by Internal Revenue Code section 72. Annuities grow tax deferred during the accumulation phase, although withdrawals during this phase are taxed on a Last In, First Out (LIFO) basis—meaning that withdrawals during the accumulation phase are considered to be withdrawals of growth first (fully taxable) and principal second. Payouts during the annuitization phase are split: a portion of each payment is considered principal, and a portion is deemed interest/growth….

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Joint-Life and Joint-and-Last-Survivor Annuities Explained

A joint-life annuity is a contract that provides a specified amount of income for two or more persons named in the contract. Income ends upon the first death. A joint-and-last-survivor contract is much more popular because payments continue until the last death among the covered lives. Obviously, this form of annuity is more expensive than other forms because, on average, it will pay income for a longer time. This increased cost is reflected in a…

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Annuity Benefit Payment Options: Fixed or Variable

Annuity Benefit Payment Options:  Fixed or Variable

Fixed-benefit annuities guarantee a minimum annuity benefit payment per dollar of accumulated value, similar to settlement options under life insurance policies. Variable-benefit annuities make no guarantees. Variable benefit payments depend on the market value of the assets in the separate accounts. About 90 percent of all outstanding annuity contracts fall into the fixed-rate category, but variable annuities are becoming increasingly popular (variable annuities are also fairly new compared to the long history of fixed annuities)….

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Investment Options Offered With Annuities

Investment Options Offered With Annuities

Fixed-rate annuities are similar to universal life policies in that amounts credited to cash values are based on the insurer’s current declared rate, subject to a minimum guarantee of 3 to 4.5 percent (varying by annuity contract and insurance company). Insurers may guarantee rates paid on new money (current contributions) for one to five years (or occasionally as long as ten years). The currently declared rate depends on the performance of the insurer’s general investment…

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When do Benefits Begin with Immediate and Deferred Annuities?

When do Benefits Begin with Immediate and Deferred Annuities?

An immediate annuity begins annuity payments within one year after the purchaser contributes all premiums. People commonly use immediate annuities when they wish to convert a large lump-sum amount, such as a substantial distribution from a qualified pension or profit sharing plan, the settlement proceeds of a lawsuit, or simply a sizeable amount of cash, into an immediate income stream. In contrast, deferred annuities, as the name suggests, delay or defer payments for a period…

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