Understanding the Taxation of Fixed Index Annuities and Multi-Year Deferred Annuities
By Hersh Stern - Revised Thursday, July 9, 2020
Annuities grow tax-deferred. When you begin withdrawing money from your fixed index or multi-year annuity, taxes become due on the earnings portion of the withdrawal. How withdrawals are treated for tax purposes will depend upon the tax-status of the premium payment you used to purchase the annuity as well as what methods you elect to receive the withdrawals.
Tax Treatment of Annuity Withdrawals
In general, gains (or earnings) which are withdrawn from fixed index or multi-year annuities are taxed as ordinary income, not as capital gains. If your annuity is invested with qualified funds, such as monies rolled over from a 401k or IRA, then the full amount withdrawn will be subject to ordinary income tax. If your annuity was funded with Roth IRA monies, and you have adhered to the requirements as set out by the IRS (maintaining the account for a minimum of 5 years and you have attained age 59-½), then all withdrawals are taken tax-free.
Examining Basic Annuity Withdrawal Strategies
When and how you take withdrawals from your fixed index or multi-year annuity contract will directly affect not only how those dollars are taxed, but the amount of lifetime income received.
If you have invested after-tax dollars into a so-called non-qualified annuity, the manner in which you take withdrawals can impact the total amount received from the contract. When you annuitize a non-qualified annuity contract, a portion of each income payment is considered return of principal by the IRS and is thus, not taxed. The remaining portion of each income payment will be taxed as earnings. When you annuitize a contract, your principal will be returned to you pro-rata in equal payments over the chosen payout period. For example, if you chose a life annuity with period certain income payments, your payout period will be calculated assuming the current IRS’s life expectancy figure for someone of your gender and age. If you live beyond the assumed life expectancy figure, you will be taxed on 100% of the income received beyond that point.
If you choose to receive income payments periodically rather than to annuitize your contract, all initial payments will be considered taxable earnings. Subsequent income payments will be considered return of principal and as such, will be received on a tax-free basis.
If you withdrawal your annuity’s cash value as a lump sum, you will be taxed on the difference between your original premium payments and the amount received.
Should Qualified Dollars be Deposited within Annuity Contracts?
One of the fundamental benefits inherent within an annuity contract is tax-deferral. Investments that grow on a tax-deferred basis appreciate at a greater rate than those invested in traditional non-qualified accounts. Does it make sense to deposit premiums into a qualified annuity? Conventional advice suggests that the answer to this question is, ‘no’ as you would already be receiving the tax deferral benefit in the qualified account. However, current trends show that many people are investing into annuities for their lifetime income benefits, not solely to receive tax deferred growth. As such, the answer to whether it makes sense to invest qualified dollars into an annuity can in many cases be ‘yes’.
Deferred Annuity table
|Company / Product||Rate||Yrs.|
|Sentinel Security LifePersonal Choice Annuity 10||3.55%||10|
|Oxford LifeMulti-Select 9||3.00%||9|
|Oxford LifeMulti-Select 8||3.10%||8|
|North AmericanGuarantee Choice 7||3.25%||7|
|Atlantic Coast LifeSafe Haven 6||3.42%||6|
|Sentinel Security LifePersonal Choice Annuity 5||3.35%||5|
|Oxford LifeMulti-Select 4||3.05%||4|
|North AmericanGuarantee Choice 3||2.40%||3|
This is a table illustrating today's top interest rates for deferred annuities. The table lists the name of the insurance company, annual effective yield, and the number of years for which the yields are guaranteed. To learn more about deferred annuities click any line in the chart or call 800-872-6684 for quick answers.