When selling annuities it is imperative that agents and brokers understand some of the basics of tax implication for annuity owners from the outset. With shifting tax and health care regulations it is important to stay on top of how year-to-year tax law changes impact annuities.
Annuity Tax Implications
Annuities are great investment strategies that can help clients defer taxes during their lifetime, thereby allowing the assets to be available for beneficiaries upon the client's death. An added bonus is that tax deferrals exist on money not removed from the annuity account. There are certain tax implications you need to consider for your beneficiaries.Tax Implications for the Surviving Spouse
The surviving spouse has the option to continue the annuity, by becoming its owner. This action prevents a distribution, and therefore allows the surviving spouse to maintain tax deferral. The entire cash value of the annuity is included in the entire estate value. This includes principal and interest. Individuals can convert part or all of the money in a qualified retirement plan or nonqualified annuity contract into a stream of regular income payments. The annuity must be paid within five years of the death of the annuitant, if annuitization has not already begun reducing the immediate tax bill. The payments are treated as ordinary income to the beneficiary.\
If the annuitant dies after annuity benefits begin, the annuity needs to be paid at the same pace as the payments prior to the death of the annuitant. But payments may also need to occur at a quicker pace to adhere to the five-year liquidation requirement. The resulting income tax may be deducted against the attributable estate tax.Life-Time Payout
A beneficiary who is eligible for a lump-sum payment may elect to have a lifetime payout to defer the taxes. Important fact: The lifetime payout must be elected prior to the 60 day period running out after the annuitant's death.
Cashing Out an Annuity without Tax PenaltiesDeferred Annuities
These annuities must be held for a minimum time period called the Surrender period. Depending on the contract, individuals may have access to a small amount of the account value (often 5-10%) without a penalty or additional fees.
Like an Individual Retirement Account (IRA), there are tax penalties for early withdrawal prior to age 59 1/2. The penalty is 10%.
However, if the annuity is a retirment qualified plan such as an IRA, then certain exceptions to the tax penalty apply such as:
- Distributions to remodel or build a home for either the client themselves, or a child/ grandchild, up to $10,000.
- Tuition payments for the client herself, a spouse, child or grandchild.