Tax deferred annuities have four separate ways of being taxed.
Accumulations
Interest earning inside an annuity has no current income tax liability. This feature makes tax deferred annuities an excellent choice for long term retirement accumulation.
Distributions
Whenever a distribution is made from an annuity, it is assumed to be interest first and therefore taxed as ordinary income. If the distribution is before age 59 ½, a 10% tax penalty is levied. Distribution after the accumulated earnings are drained are considered a return of premium (principal) and are not taxed.
Lifetime Income
Distributions that are essentially lifetime payouts are not taxed on the basis of first out. Instead, the tax is spread over the expected life of the payments. For example, assume that the interest earned is $120,000 and the life expectancy is 20 years. The interest will be taxed at the rate of $6,000 a year. Remember that the payout will also include a return of principal. Therefore, only a portion of the annual payments will be taxable.
Income Taxes at Death
At the death of the annuitant the entire proceeds of the annuity are passed to the beneficiary. At the time of transfer, any accumulated interest is taxed to the recipient at their personal tax bracket.
Tax Planning
The ability of annuities to defer income taxes and to select the taxation of distributions offers considerable tax planning flexibility. Ask you Annuity Coach to help determine the most tax efficient use of your annuity.
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Compliance # CSP_1052 20160608