Annuities are usually tax-deferred funds, treated similarly to IRA and 401(k) retirement plans. The income becomes taxed during distributions of the income. The withdrawn income is taxed according to the amount.
People plan on an annuity as a safe way to receive income during retirement without the risks of investing in stocks, bonds and mutual funds. The way the distributions are made determines the taxable income,
according to Ameriprise Financial.
The taxation would occur immediately with an immediate annuity. Under this plan, the annuitant might pay a lump sum amount for the premium and begin automatic withdrawals on a monthly, quarterly or annual basis through the insurance company with normal taxation on the distributions.
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Some annuities are deferred, so the annuitant funds the account until distributions begin on a specific date when taxation also begins.
Because annuities are often funded with after-tax dollars, the premiums don't have the advantages of other federal retirement programs. You can't deduct the premium on your tax return as you do with funds placed in an IRA or 401(k).
Taxes on scheduled distributions depend on the annuity options you have chosen. There are a variety of annuities available that may offer periodic or lump sum distributions.
Depending on your plan, distributions might include a percentage of the annuity's principal and the earnings of the fund. You can avoid taxation of the principal, but earnings will be considered taxable income, reports Ameriprise Financial.
Lump sum distributions may occur a few years after you began funding the annuity if you decide on that option. The distribution of earnings will not only be treated as taxable income, but could also put the annuitant in a higher tax bracket.
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You face tax penalties for early withdrawal when you take money out of the annuity before age 59 and a half. However, the IRS does allow exceptions, such as in cases of a disability.
Annuity earnings are taxed upon death. With an IRA annuity, beneficiaries can stretch the funds to reduce taxes,
according to MarketWatch. Beneficiaries can use the stretch strategy to take out the deceased IRA owner's required minimum distributions over time. This reduces taxes of taking out the amount in one lump sum.
Taxation of annuities and other investments often change, especially in certain states that have added a premium tax to annuity income. Talk to a financial advisor as well as an annuity agent about taxes and changes when considering an annuity.
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