Are There Unknown Taxes on Annuities?

jasonten

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I own a few annuities and am curious if I will have a tax surprise later?

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When Your Annuity Becomes a Tax Time-Bomb

Tax Deferred Annuities issued by life insurance companies have for years been a popular alternative for people who want high interest and tax relief for their savings. In the last 20 years, billions of dollars have been moved into these contracts by savers seeking safety and predictability, competitive interest rates and favorable tax treatment. If you currently own a tax deferred annuity or are contemplating investing in one, there is something you should know that is seldom mentioned by the company or the agent who presents it.

One of the most important features of a tax-deferred annuity is that it allows you to compound yearly interest earnings free of current tax. By eliminating the current tax cost of accumulation, you can build a much larger account value than with a typical interest bearing account such as a bank CD. When you combine this feature with a slightly higher interest rate than is typically found in bank savings, it is easy to see why tax-deferred annuities are so popular.

Annuities are great for safely accumulating money to be used at some future date to enhance income; as long as it is understood that when you begin to withdraw money from the annuity, you must then pay taxes on your gain. The manner in which you chose to take income will determine the method used to calculate taxable income. A simple partial withdrawal is usually the most desirable method, but it is treated as interest first, which often means the entire withdrawal will be taxable. Only if you set up a systematic annuity income payment, will you get some tax relief by spreading out the taxable gain over the anticipated number of years that annuity payments will be made. This does not reduce the amount that will ultimately be taxable, but it does spread it out and make the burden more palatable.

The Unknown Tax Trap
It is at the time of the total withdrawal of funds, which most often occurs upon the death of the annuitant/owner, that the surprise occurs.

A deferred annuity is the only asset you can own that does not get a “step-up in basis” at the time of your death. It is quite common today to see real estate and stocks that have been owned for years and that have appreciated ten fold to a hundred fold be passed on to heirs upon the death of the owner with no income tax whatsoever. But an annuity does not enjoy this tax feature. Specifically excluded from the step-up in basis rule, the entire gain in the annuity is subject to income tax when received by the beneficiary.

Since a vast majority of the $Billions now residing in annuities is destined to be passed on to the children of the annuitants, the tax bills will come as a tremendous shock to all concerned. In fact, it is not uncommon to see proceeds from an annuity that has been accumulated and tax deferred in a relatively low tax bracket (15% or 20%), incur taxes of 33% or more when added to the existing income of the beneficiary. This clearly was not the intent of the contract owner. But it occurred because of the failure to recognize the ultimate purpose for the money on deposit in the annuity and to choose the most appropriate strategy.

The Better Strategy
There is an alternative to the annuity that will satisfy the new objectives of saving money for an emergency and passing any unused balances to our heirs. This alternative provides tax deferral, safety and immediate liquidity. It has the same tax provisions for partial withdrawals as annuities but when it passes to a beneficiary upon the death of the owner, there is a major difference. The entire tax-deferred accumulation passes income tax-free to the named beneficiary.

The product is a special life insurance policy designed for maximum cash value growth to duplicate as close as possible the level of accumulation typical of an annuity. People who are planning on passing their savings on to their children at death will find that the after-tax benefits will be substantially higher if the money is accumulated in a life insurance policy rather than an annuity when they die. Not only does it include the money which accumulated in the cash value account, but an additional amount of life insurance benefit that is paid to the beneficiary. This combination, paid income tax free, is the most desirable way to pass savings to children or other named beneficiaries."

this is from annuityadvantage

Can someone please help me to understand this better?
 
Just keep it simple: if you want a death benefit buy life insurance. If you want income either now or later get an annuity or invest in mutual funds. If this income is coming from an IRA, then none of these tax issues are relevant. An annuity in an IRA is taxed the same as anything else in an IRA
 
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"Tax Time-Bomb"

A dramatic and grossly exaggerated headline typical of whitepapers that people want you to download.

Annuities do have a basis. It is the same basis a gift to your children while you are alive would have as opposed to them inheriting the same thing from you.

So, this time-bomb is that you inherit an annuity and are responsible for taxes on the growth the annuity has experienced, but not the original investment in the annuity -which you get tax free. I would say that the taxable "growth" of annuities has not really been stellar for a number of years now -on average.
 
Just keep it simple: if you want a death benefit buy life insurance. If you want income either now or later get an annuity or invest in mutual funds. If this income is coming from an IRA, then none of these tax issues are relevant. An annuity in an IRA is taxed the same as anything else in an IRA

agreed. over thinking can lead to complicating everything
 

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