How Is a Non-Qualified Annuity Taxed?
Stan The Annuity Man here. Welcome. Today, we are answering how a non-qualified annuity is taxed. Disclaimer: I'm not a tax lawyer. I'm not a CPA. You need to talk to those people. Do not take tax advice from people who haven't earned the right to give tax advice. It's like asking a fat person how to be skinny. You don't do that. All right? Don't ask people who don't do taxes how to do taxes. "Now, you're just saying this stuff. Hey, wait a minute, we're talking about taxes, right, Stan?" Yeah, you ask, so I have to do this blog.
Let's talk about how non-qualified annuities are taxed. I'll give you the 30,000-foot view from the B-2 bomber. But you got to come down here to the fighter pilot, and that's the tax lawyer, when you get down to the end, and you're trying to make a decision. So, we will cover all that and all types of annuities in a non-qualified account. Non-qualified means non-IRA. That's what that means. So, we're going to talk about that. At the end of the blog, I will tell you how you can get quotes and get my books for free. So, hang in there with me. We're going to talk about the ugly word: taxes.
The Annuity Types
Non-qualified annuities, meaning the annuity is not in your IRA. And we're not talking about Roth IRAs, not in your traditional IRAs. So, it's in a non-IRA account. How are those annuities taxed? Let's go through the primary types.
Immediate Annuities, which is a pension-income-now-type product in a non-qualified setting, is going to be a combination of return of principal plus interest based on your life expectancy at the time of the payment. So, you won't pay taxes on the return of principal. You'll just pay taxes on the interest side until all the money's gone. Once the money's gone, you pay taxes on it all. All right? It's based on your life expectancy.
Deferred Income Annuities
Same thing for deferred income annuities in a non-IRA setting. It's an annuitized product. You turn on the lifetime income stream, and it's a combination of return of principal plus interest. When the money's all gone, you'll pay taxes on the full income amount. But up until that point, you'll only pay taxes on the interest.
Qualified Longevity Annuity Contracts
Now, qualified longevity annuity contracts don't fit here. Why? Because that's used in traditional IRAs.
Multi-Year Guarantee Annuities
Let's talk about Multi-Year Guarantee Annuities. Multi-Year Guarantee Annuities in a non-qualified setting. First, there is good news in a non-qualified setting because it's like a CD product. CDs, you have to pay taxes on the interest every year. With Multi-Year Guarantee Annuities, Fixed-Rate Annuities, you do not have to pay taxes on the interest. Every year, it compounds and defers. But when you pull the money out, it's taxed LIFO, which means last in, first out. English, please? That's gains first. So, you're going to take the gains out first. You're going to pay taxes on those first. Last in, first out.
Fixed Index Annuities
Same thing with fixed-index annuities. If you have a Fixed Index Annuity, it's grown, and you'll take money out, you'll take gains first out. It's going to be taxed last in, first out. So that's kind of, in my world, the Fixed Annuity world, which is Stan The Annuity Man. License in all 50 states; that's how it's taxed. But again, you need to talk to your tax advisor. In other words, if you have annuities in your portfolio now, and you're trying to figure out the best way to take money out of those annuities, you need to talk to your tax lawyer or CPA.
One other thing that might be of interest is with Deferred Annuities, like Multi-Year Guarantee Annuities or Fixed-Index Annuities, you can get to the end of the contract, and instead of taking lump sums out and being taxed last in, first out, in a non-qualified account, you can convert those into Immediate Annuities and take advantage of what we call the exclusion ratio, which is that combination of return of principal plus interest, and maybe it would be a more tax-favorable decision for you.
I know I've thrown a lot at you. That's why I'm yelling at you to see a professional. And we can work directly with them as well, especially if you already have annuities in your account. But if you don't and are thinking, "Should I get an annuity in a non-IRA setting? How would it be taxed?" Remember, Immediate Annuities and Deferred Income Annuities are annuitized products; it's an exclusion ratio, a combination of return of principal plus interest. Multi-Year Guarantee Annuities and Fixed-Index Annuities, that's last in, first out if you're taking the money.
If you have an Income Rider attached to one of those, and I know I'm throwing a lot at you. Sorry. That's the reason you got to contact me. But if you have an Income Rider attached to an Index Annuity or a Multi-Year Guarantee Annuity, some do have those, then that's a last in, first out as well, gains first with most Income Riders attached to Fixed Annuities. I know that's a lot, so hang in there with me.
Okay, so I got a call the other day. A guy had a Multi-Year Guarantee Annuity he had held forever. Remember, that's a Fixed-Rate Annuity like a CD. And so, it had grown; it had almost tripled. And he said, "Well, I could take money out." And he said, "But I'd really like to turn it into an income stream for my wife and myself." And I said, "Fine, we can do that, but there are a couple of rules."
Number one, the IRS has a section, if you're really, really bored and have no life whatsoever. Go to Section 1035 of the IRS Code. And what that says is you can transfer from one annuity to another annuity in a non-IRA setting. And it's a non-taxable event. It doesn't trigger any taxes. So, you can go from X, Y, Z annuity to A, B, C annuity, wire-to-wire transfer, and it won't create taxes.
However, in this situation, we wouldn't shop for the best Immediate Annuity rates for this person's dates of birth for him and his wife and how they wanted to structure it. And so, we came up with the top five carriers. He chose one, and then we said, "Okay, we can do a 1035 IRS-approved transfer from your current Fixed-Rate Annuity to the Immediate Annuity, but the cost basis, the original cost basis, transfers to the Immediate Annuity."
The cool part about that is when he turns on the income stream from the Immediate Annuity, that cost basis is figured in, but they're going to, in essence, lengthen out that tax liability over their life expectancies. He's still going to get an exclusion ratio. It will still be a combination of return of principal plus interest. They're just going to factor in the cost basis and then lengthen that liability out over his life expectancy, which he liked.
Instead of cashing it all in and cashing the Multi-Year Guarantee Annuity in and paying all the taxes last in, first out on all that gain, he transferred it with cost basis to the Immediate Annuity and created a lifetime income stream and then lengthened out that tax liability. That's some Stan The Annuity Man inside info that you need to know.
All right. Not my favorite subject, taxes, because I don't like paying taxes, a lot of them. I assume you don't either, but we must cover them. And I hope we have answered the general questions about how's a non-qualified annuity is taxed. I would encourage you to watch this video as well, which is on Income Riders, which is a little bit more complex. The good news is, let me find it. Drum roll, please? Income Rider owner's manual. It's one of the six owner's manuals I've written, and I'm going to tell you how to get those in two seconds, but you have to do one thing for me right now. Hit the Subscribe button on my YouTube channel. Be part of the Stan The Annuity Man YouTube family. Why wouldn't you be? You have no answer for that. That's good.
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