How Are Annuity Income Riders Taxed?
Hi there. Stan, the Annuity Man, America's annuity agent, here with you again. You have typed into the bar, the bar screen, the Google thing, how are Income Riders taxed? That is an excellent question. I will answer it very briefly, and then we will dig deep, so hang in there with me. The answer is, depending on the type of rider you have attached to your Deferred Annuity. A rider is an attached benefit for income, that will determine how that income stream coming from that rider is taxed. Most of the riders sold today are withdrawal benefits, so those are taxed last in, first out, ordinary income, but let's dig deeper a little bit.
Income Rider Types
Okay, so there's not just one Income Rider out there. I wish there were. It would make this blog much shorter and life easier, but annuity companies don't work that way. They have to be complex, as they say, so let's talk about Income Riders again. Income riders are attached benefits. Most of the riders attached to policies today are attached to either Variable Annuities or Fixed Index Annuities. Many of them are on the Fixed Index side, but there are two types of riders, and we'll talk about the taxation of each. Side note, for taxation issues, please see your CPA or tax lawyer, don't listen to an agent. I'm giving you a 30,000-foot view, of which you can then talk to your qualified tax professional.
Here are the two types. The first type, and this is primarily what's out there, is called withdrawal benefits. And then, the second type is annuitized. Now, most of you are probably under the assumption that they're all what's called annuitized. Annuitization, in real terms, is like ripping the knob off a water faucet, and the water's flying. Annuitization, when you do that to an annuity, creates an irrevocable lifetime income stream. There are only a few income riders that are annuitized. A lot of them are on the Variable Annuity side, but annuitization is an income stream based on your life expectancy at the time you take the payment, and so is the withdrawal benefit.
The difference between the two is with the annuitized side, you've lost control. The income stream is coming, regardless. No control, no pivot. You can't say, "Hey, I'm annuitized." This Income Rider that's annuitized is typically called a GMIB, Guaranteed Minimum Income Benefit rider. I don't want to get too much in the weeds, but that's an annuitized rider. That thing's going to pay, period. You can't call and say, "Hey, I don't want to do that anymore." Now, the good news is that most of the stuff that's being sold out there today on the Income Rider side is what's called withdrawal benefits. Withdrawal means subtraction. All annuity income streams, regardless of the type, Immediate Annuities, or Income Riders, are a combination of return of principal plus interest. But the good news about the withdrawal benefit rider is you have full control over the asset, meaning that you can shut it on and off.
Let's go through an example. Let's just say that your walkaway amount is worth $200,000, and your Income Rider is worth $250,000. Same annuity, different calculations. When you turn on the lifetime income stream from that Income Rider, and that income starts, let's say that income is $5,000 a month. $5,000 a month will be subtracted from the walkaway amount, and $5,000 a month will be subtracted from the Income Rider. Does that make sense? Now, with most Income Riders, you can turn that off if you want to. When you turn it back on, it will start at the same level where you stopped it, but the taxation of it comes down to what type of account you're in.
If you're in an IRA, the Income Riders inside of a traditional IRA, any money coming outside of an IRA is taxed. I don't care what it is, it's going to be fully taxed at ordinary income levels. With Income Riders outside of an IRA, gains first, LIFO. Non-qualified equals LIFO, Last In, First Out, which means gains first on that income stream. Once you get to the principal, then that's not taxable but gains first on most Income Riders out there. Like I said before, if it's annuitized, it will be a combination of principal plus interest. But most of the Income Riders you'll see out there, especially at the bad chicken dinner seminars, are withdrawal benefit riders, and those will be last in, first out, taxable outside of an IRA.
One of the most popular books I've written, and I've written a bunch, is on Income Riders. I've written an Income Rider owner's manual, and I think at this point in the blog, it might be a pivotal time to talk about it because you can get it for free, with no obligation, and no cost. Click here, input some basic information, and choose which owner’s manual you would like to download for free.
In the owner's manual, I go over all types of Income Riders, the withdrawal benefit riders we talked about, and the annuitized riders we talked about, both on fixed and variable. I cover them all, the good, the bad, and the ugly so that you fully understand what you're buying or what has been sold to you. Understand that the state guarantee fund does not cover income rider benefits; it's the accumulation value. Income Riders should be used solely for income later, future income needs, and pension-type needs.
In my opinion, they do work, but if you're going to get that quote for Income Riders, get a Deferred Income Annuity quote as well. Another video you should take a look at are how qualified annuities are taxed. I dug deeper into it than what we just did. We just talked about Income Riders today. In that video, I reviewed all types of annuities and their taxation. You should dig into that if they're inside of an IRA-qualified type of money. As you're probably catching from Stan the Annuity Man, America's annuity agent, I am also America's annuity educator because I've written so many books. I've got podcasts, and obviously, I do a bunch of YouTube videos and blogs.
I'd love for you to subscribe to our YouTube channel because I do one every single day, Monday through Friday, for infinity, God willing, so I can keep doing these and educating the public. Feel free to always go to my site, if you want to see quotes or if you want to book a call and talk to somebody about your specific situation. Hopefully, that person will be me. If I'm in the office, I'll talk to you, and we'll work up a specific plan and strategy and get you some quotes so that you can decide on your terms and timeframe. With that, see you next time.
Never forget to live in reality, not the dream, with annuities and contractual guarantees! You can use our calculators, get all six of my books for free, and most importantly book a call with me so we can discuss what works best for your specific situation.