Annuity Taxes
(How much do you get to keep?)
Written by
Jeff Green has held a variety of sales and management roles at life insurance companies, Wall street firms, and distribution organizations over his 40-year career. He was previously Finra 7,24,66 registered and held life insurance licenses in multiple states. He is a graduate of Stony Brook University.
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Neel Lane is an independent contract paralegal who specializes in Medicaid and VA benefits. He helps people access and maximize the benefits that they're entitled to. He has over 30 years of experience in this area.
Uncle Sam wants us to save for retirement. That’s why annuities have special features and tax benefits. Where there are tax benefits, there are usually strings attached. Annuities are no exception.
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So what exactly is Uncle Sam’s share of your annuity?
Taxes on Traditional Qualified Annuities
Traditional qualified annuities are part of traditional pension plans and IRAs. Contributions to traditional qualified annuities are made with pre-tax dollars. Generally, proceeds received from traditional qualified annuities are 100% taxable at ordinary rates.
Loans and sales are not permitted from an IRA. Loans may be available from a traditional qualified annuity in a pension if the proceeds are used to purchase a home or are repaid within 5 years. Loan proceeds are not taxable under the exceptions.
Taxes on Roth Plan Qualified Annuities
Roth plan qualified annuities are part of Roth pension plans and IRAs. Usually, proceeds received from Roth plan qualified annuities are tax-free.
Loans and sales are not permitted from an IRA. Loans may be available from a traditional qualified annuity in a pension if the proceeds are used to purchase a home or are repaid within 5 years. Loan proceeds are not taxable under the exceptions.
Taxes on Non-Qualified Annuities
Non-qualified annuities are personally owned and paid for with after-tax dollars.
Non-qualified annuities are taxed at ordinary income rates.
Annuity income is partially taxable. The amount of the annuity payment that is considered principal is excluded from taxable income. The exclusion is calculated based on the expected number of payments. Withdrawals are taxed as interest first until the growth is exhausted.
Loans are taxed as withdrawals. Surrenders are taxed based on the surrender value minus total interest paid.
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Penalty Taxes
Traditional qualified, Roth-qualified and non-qualified annuities all have a 10% penalty tax for withdrawals before age 59-½.
Both plans also have a 10% penalty for withdrawals taken before the end of five years.
Taxes on Annuities at a Glance
Below is a summary chart of the tax impact for the different plans and transactions.
| Non-Qualified | Qualified | Qualified/Roth | |
| Contributions | After-tax. Unlimited | Pre-tax. Limits for IRAs and qualified plans apply. | After-tax. Limits for IRAs and qualified plans apply. |
| Growth | Tax-deferred | Tax-deferred | Tax-deferred |
| Surrender | Gain is taxed at ordinary rates. | All proceeds taxable | Tax-free |
| Annuity Income | Partially taxable at ordinary rates | 100% taxable at ordinary rates | Tax-free |
| Withdrawals | Withdrawals are gain first. Gain is taxed at ordinary rates. | 100% taxable at ordinary rates | Tax-free |
| Loans | Loans are considered withdrawals. Gain first is taxed at ordinary rates. | IRA loans not permitted. Pension plans may have exceptions for home purchase and loans repaid in 5 years. | IRA loans not permitted. Pension plans may have exceptions for home purchase and loans repaid in 5 years. |
| Death Benefits | Gain is taxed at ordinary rates. Proceeds will be taxed as "gain first." | Rules for inherited traditional IRAs and qualified plans apply. | Rules for inherited Roth IRAs and plans apply. |
| Sales | Proceeds in excess of basis taxed at ordinary rates. | N/A | N/A |
| Penalties | 10% for withdrawals before age 59-1/2 | 10% for withdrawals before age 59-1/2 | 10% for withdrawals before age 59-1/2 Penalty for withdrawals prior to end of the 5th year |
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The Bottom Line
Annuities are a financial tool that offers tax-deferred growth and in some cases tax-favored income. Be sure to consult your professional advisor for tax and legal advice.
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