Personal Finance Insight ? Blog Archive ? What are the Tax ...
Retirees exceptionally like annuities since annuities can assure them an income for lifetime. However some retirees will die before beginning their annuity or receiving all their guaranteed annuity benefits. Their beneficiaries will then receive those benefits. This article clarifies how those beneficiaries are taxed on those benefits.
Retirees often hold their annuities as deferred annuities as a back-up for those later retirement years when they?ll commence annuity payments only when other retirement income falters or when savings become depleted. However if they die before beginning their annuity, the designated annuity beneficiary will have to pay tax on all or a part of those benefits. The same is fair for annuities that have begun their payouts however those payments are guaranteed for some term of years beyond which the annuitant?s owner died.
Annuities that are made within a administration regulated qualified plot are called qualified annuities. All the owner?s contributions to them are deductible, so all the annuities earnings and contributions will be taxed as ordinary income no affair who receives those annuity payouts.
However most annuities are nonqualified. In this condition the contributions owners made to them are not deductible (i.e. they are after tax contributions). These contributions will never be taxed by anyone; they constitute the ?tax basis? of their annuity investment contract.
However all nonqualified annuity earnings are tax-deferred. This helps the annuity investment to annually compound quicker since part of those earnings is not taxed away each year so it can participate in prospect growth. However those tax-deferred earnings will eventually be taxed upon withdrawal ? by either the owner or his beneficiary.
*Annuitant?s (owner?s) taxation:
If a partial withdrawal is made, the IRS demands that all earnings come outside first before the any untaxed contribution (i.e. the basis) comes outside. So these withdrawals ? as extended as there are earnings within the annuity ? are completely taxable as income.
However under regular monthly payments ? as when the annuity is ?annuitized? ? a part of each payment is not taxed however treated as a giveback of your contributions (i.e. your tax basis) while the remaining part is treated as earnings ? and taxed as income. This is one of the tax benefits of annuitization payments. An exclusion ratio is the ratio of the monthly annuity payout that?s not taxed. It?s calculated for you by the insurance corporation.
Under a lifetime annuity, it?s imaginable that an annuity owner will live beyond his lifetime expectancy and receive enough payments to have recovered all his contributions (i.e. his tax basis). When that occurs, all of each subsequent payment is fully taxed as earnings ? i.e. there?s no longer an exclusion ratio.
*Beneficiary?s taxation:
After-tax contributions made by the deceased owner will remain untaxed when received by the beneficiary as I mentioned above. And of direction, all those tax-deferred earnings within the annuity will be taxed as ordinary income to the beneficiary.
Usually, if the annuitant had begun receiving lifetime payments, no benefits would be left for a beneficiary. However if the contract called for a fixed term guaranteed payments, the beneficiary would received those remaining payments of that fixed term taxed at the deceased?s exclusion ratio.
If the annuity owner died before beginning annuitization of his annuity ? so the annuity was still a ?deferred annuity?- provision may be made to give the beneficiary either a lump sum distribution of the deferred annuity or a series of payments. For the lump sum payment, the beneficiary would only pay tax on the earnings part.
However if he takes a series of guaranteed payments instead of a lumpsum, the beneficiary would not be required to pay taxes on any of the payments until the deceased owner?s contribution were fully received. So the annuity?s basis would presume to be withdrawn first. Any payments beyond that would be fully taxed as ordinary income.
A beneficiary who earns a substantial income already can lose a abundance of that taxable part of the annuity as he?s it pushes him into a higher tax bracket. That?s why a lump sum distribution may be exceptionally terrible for him.
Shane Flait helps you with your financial legal, tax, and retirement goals.
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