Taxation of annuities
If you have an annuity, there are different potential implications for your retirement savings and income based on the type of annuity you have and when you withdraw funds.
To make the most of an annuity, it’s important to consider their general tax rules.
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Taxes are determined by the specific type of annuity you purchase -- either qualified or non-qualified. With a qualified annuity, you fund your annuity with pre-tax dollars, while non-qualified annuities are funded with post-tax dollars. This also affects the tax treatment of your payouts.
- Funding: Qualified annuities are generally funded with pre-tax dollars
- Distributions: Qualified annuities are subject to Required Minimum Distribution (RMD) guidelines. You must begin taking distributions from a qualified annuity by April 1st of the year after you turn 72.
- Payouts: You will pay normal income taxes on the entire distribution amount. Annuities purchased with a Roth IRA or 401(k), however, may be tax free if specific requirements are met.
- Other considerations: If you invest in an annuity to fund a retirement plan or an IRA, the annuity will not provide additional tax deferral benefits for that retirement plan or IRA plan.
- Funding: Non-qualified annuities are funded with post-tax dollars and grow tax deferred.
- Distributions: Non-qualified annuities are exempt from Required Minimum Distribution guidelines. Once you start taking distributions from a non-qualified annuity, any interest or earnings within the annuity will be distributed before the premium or principal amount.
- Payouts: The interest (or earnings) are taxed as ordinary income but you won’t pay taxes on the premium or principal you initially deposited.
An annuity can be a smart addition to your retirement plan but it’s important to keep in mind that if you make a withdrawal prior to the designated time period, you can expect to pay early withdrawal penalties on your annuity.
- Annuity withdrawals made before you reach age 59½ are typically subject to a 10% early withdrawal penalty tax. For early withdrawals from a qualified annuity, the entire distribution amount may be subject to the penalty. If you withdraw money early from a non-qualified annuity, typically only earnings and interest will be subject to the penalty.
- While there aren’t many exceptions to the 10% early withdrawal penalty, you can explore potential options with your tax advisor that may be available to you based upon your individual circumstances.
- In addition to potential tax penalties, withdrawals may also be subject to surrender charges by the annuity issuer. This may happen if the amount withdrawn exceeds any penalty-free amount during the surrender charge period. Surrender charges vary by the annuity product you purchase, so make sure to check with the annuity issuer before withdrawing money from an annuity.
If you are considering withdrawing from your annuity early, it’s a good idea to speak with a tax professional.
An Ameriprise financial advisor can help
Annuities offer steady income and tax benefits making them a popular way to save for retirement. There are a variety of annuity products available to help meet retirement savings and income needs. An Ameriprise financial advisor can review your individual financial situation and partner with your tax professional to evaluate your annuity tax strategy.
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