The Facts About Taxes and Fixed Annuities

One of the major benefits of a fixed annuity is the important tax advantage during the accumulation phase of your contract. And to get the most from your annuity, it's important to understand the rules surrounding withdrawals as well. Here are seven key tax facts to help you make the most of your choice of a fixed annuity:

Fact #1 - The Advantage of Tax-Deferred Growth on Earnings
Every dollar of interest generated in a fixed annuity continues to work for you up to the day you begin making withdrawals. That allows your dollars to grow faster to help you meet your goals.

Hypothetical Growth Comparisons
Growth of $100,000 over 15 years, earning 6% (assumes tax rate of 27.5%)
Tax-deferred investment	$239,655
Taxable investment	$189,902
After-tax value of accounts assuming lump-sum distribution (assumes tax rate of 27.5%)
Tax-deferred investment	$201,250
Taxable investment	$189,902
This chart assumes a 6% hypothetical growth rate and a federal tax rate of 27.5%. This chart does not reflect the taxation of the tax deferred investment when the funds are paid. Were this tax reflected, the amount of the tax deferred investment would be lower.

Fact #2 - Simplified Tax Reporting
With no taxes to pay while your money works within the annuity, tax reporting is easy. Generally, you do not receive any IRS 1099 forms (as you would with taxable investments) during the accumulation phase of your annuity contract. In most cases, there is no additional effort required on your tax return until you begin to withdraw money from your account.

Fact #3 - Flexible Distribution Options
Unlike IRAs or workplace retirement plans, you aren't required to take distributions from your non-qualified annuity at age 70 1/2. Traditional IRAs and workplace plans such as 401(k)s and 403(b)s require distributions to begin after you reach age 70 1/2. With a fixed annuity, you can let your money grow on a tax-deferred basis past age 70 1/2.

Fact #4 - Tax-Free Exchanges
The so-called "1035 exchange" involves switching one non-qualified annuity for another without taxes on your assets switched between contracts. It is a relatively simple process, provided you follow the rules carefully. When handled correctly, a 1035 exchange allows you to avoid taxes on the transaction. For more information on rules surrounding tax-free exchanges, click here.

Fact #5 - Potential Tax Penalties
Some tax advantages are lost if you withdraw earnings before reaching age 59-1/2. Along with paying any taxes due (on the full amount withdrawn at your ordinary income tax rate), you may also be required to pay a 10% tax penalty on the amount you withdraw.

Fact #6 - Taxation of Standard Annuity Withdrawals
You have the ability to annuitize your contract, allowing you to receive a regular stream of income. Typically, taxes are not due on any payments which represent the return of your cost basis (the premium you paid). The portion of withdrawals that represent earnings are subject to taxation (see the "exclusion ratio" discussion below). This tax treatment will not apply if you made any withdrawals during the accumulation phase.

Generally all contributions to a qualified plan are made on a pre-tax basis. This means, upon distribution, all amounts distributed from a qualified plan are subject to tax at ordinary income tax rates. Also, if you withdraw your contract value in one lump sum, it could push you into a higher tax bracket.

Fact #7 - Use the Exclusion Ratio When Making Withdrawals
When dollars are withdrawn from your annuity (assuming it is not part of a qualified plan or IRA), not all of the withdrawal is taxable. The exclusion ratio is used to determine the taxable portion of the annuity payment you receive. This is calculated by dividing the current value of the account by the expected return.

Content is for informational purposes only and may not accurately reflect your specific situation. Information is not intended to provide financial, legal, tax, or accounting advice. You should consult a qualified advisor for advice specific to your own circumstances.