| An annuity is both a contract with an insurance | | | | contracts total value - i.e. earnings plus contributions. |
| company and an investment. Your contributions (often | | | | After you've received all your contributions back in |
| called premium payments) to it are invested to | | | | payouts, all future payouts are fully taxed as income. |
| produce earnings. This article explains when and what | | | | Taxation on withdrawal from your deferred annuity |
| is taxed as income under annuitization, withdrawals, | | | | accumulation: |
| and gifts of your annuity. | | | | Taking money out of your deferred annuity is a |
| An annuity has two phases: accumulation and | | | | withdrawal. But earnings are considered to come out |
| annuitization. During accumulation - called a deferred | | | | first. So anything you withdraw is taxed as income until |
| annuity - both your contributions (i.e. premium | | | | all the earnings are out. Any withdrawal beyond |
| payments) and their earnings accumulate within the | | | | earnings is a tax free return of basis. |
| contract. During annuitization (i.e. payout stage) you | | | | Until you've turned 59 years old, the IRS imposes a |
| receive monthly payments while money remaining in | | | | 10% penalty tax on what you take out of your |
| the contract creates more earnings. | | | | nonqualified annuity too. |
| Most annuities are nonqualified. You can make unlimited | | | | This withdrawals taxation also includes cashing out |
| after-tax contributions to them and their earnings grow | | | | your deferred annuity altogether. An early cash out |
| tax-deferred. Only the tax-deferred earnings are | | | | may trigger an additional fee from the annuity |
| eventually subject to income tax; your contributions | | | | company. |
| come out tax-free as a return of your basis in the | | | | Taxation on a gift of your deferred annuity: |
| contract. | | | | Gifting your deferred annuity to a person, charity or a |
| A qualified annuity is one regulated under government | | | | charitable remainder trust, triggers income tax on the |
| rules as a retirement plan. All contributions to them are | | | | annuity's earnings; that includes any 10% penalty tax |
| deductible from income but, of course, must come | | | | too. |
| from working income. | | | | For gifting to a government-approved charity, your |
| Annual contributions are limited like IRA contributions. | | | | deduction is limited to your basis in the contract - i.e. the |
| Since they have no after-tax contributions, your tax | | | | sum of your contributions. |
| basis in the contract is zero; so all withdrawals will be | | | | Qualified annuities are taxed as above accept they |
| subjected to income tax. | | | | have no basis - i.e. basis equals zero. |
| Like all qualified plans, any withdrawal you make | | | | Taxation on beneficiaries and survivors: |
| before reaching age 591/2, will have a 10% penalty tax | | | | Annuities that go to beneficiaries and survivors are |
| imposed on it in addition to income tax. After reaching | | | | considered as 'income in respect of a decedent' - and |
| 701/2, you're required to make minimum required | | | | not as an investment. So an annuity - unlike an |
| distributions - just like IRAs. | | | | investment - doesn't get a stepped-up basis. |
| Income taxation is imposed on: | | | | So, any annuity payout to survivors and beneficiaries is |
| * Annuitization | | | | subject to income tax - but only to the extent that |
| * Accumulation withdrawals | | | | money paid out to them exceeds the annuity's basis |
| * Gifts of an annuity, and | | | | -i.e. the original owner's annuity contributions. So a |
| * Beneficiary's withdrawals | | | | portion of each payout will be attributed to the |
| Let's see how nonqualified annuities are taxed: | | | | deferred tax on the earnings of those contributions |
| Taxation on annuitization payments: | | | | and a portion will be return of basis. |
| Your monthly payouts are considered as made up of | | | | As it was for the original owner, when the basis has |
| a contribution part and an earnings part. Only the | | | | been completely recovered through payments to the |
| earnings part is taxed as income. It's a specific fraction | | | | beneficiary, all further payments will be fully taxed as |
| of your payment equal to total earnings divided by the | | | | income. |