Show #279, Airing Sunday, January 9, 2005
There’s lots of hype around annuities. But what are the facts? Can they help you keep more of your money at tax time? Here to explain is Tony Mercuri from Ta-Check Tax Service.
Question: What is an annuity?
Answer: That can be a difficult question to answer. The short answer is that they are a tax-deferred investment vehicle sponsored by insurance companies. There are several types of annuities:
- Fixed, like a CD, with a guaranteed rate of return, principal guaranteed, and a certain time period.
- Variable, which work like mutual funds, with the return based on the performance of the sub-accounts.
- Equity indexed annuities, which have a guaranteed minimum return tied to an index.
Question: Do annuities offer tax benefits?
Answer: Yes.
- The major advantage is tax deferral. All of the annuities I just mentioned provide tax-deferred growth, similar to an IRA.
- This can help some folks avoid paying tax on their Social Security income, because the income from annuities is not counted when determining whether or not your Social Security is taxed, where the income from, say, municipal bonds is used in the calculation.
Question: When do you pay tax on the earnings?
Answer: Like with IRA, only when you take out.
Question: Is everything you take out taxed?
Answer: If your annuity is an IRA Annuity, then you follow IRA rules, and all of the money is taxable.
However, if you have a non-qualified annuity, so it is NOT an IRA, then only the growth on the annuity is taxed. The principal portion is not taxed, as you have already paid the tax on that portion. Let’s assume you purchased an annuity for $30,000. Seven years later it grew to $45,000 and you cash it in. You would receive $45,000 but only pay tax on the $15,000 of growth.
Quetion: What's the tax rate?
Answer: Regular income tax rates.
Question: What if you purchase the annuity for $30,000 and it grows to $45,000. Then you take out $5,000. How much is taxed?
Answer: $5,000. The first money out is taxed. Until you take out $15,000, then it is all taxed.
Question: What if you buy an annuity and it goes down?
Answer: You can write off loss against other income.
Question: Do you have to take minimum distributions at age 70 1/2?
Answer: Only if the annuity is in an IRA.
Question: What happens if you own an annuity at death?
Answer: The tax is passed on to kids. One benefit to the annuities is they avoid probate, because you actually name a beneficiary on the annuity contract.
Naming the beneficiary properly is very important as it can provide benefits to the heirs and help keep more money in your bloodline and less to Uncle Sam. The beneficiaries, if done properly, can elect different payout options so they can choose the one that is most advantageous to them.
As Tony’s explained, annuities offer some nice tax advantages. But they also have tax disadvantages, and Tony will be back next week to talk about those. In the meantime, if you’d like a free annuity tax analysis, give Tony Mercuri a call.
