What Is a Cost Basis on an Annuity?
So what is a cost basis on an annuity? I'm going to talk about the cost basis of all different types of annuities, the deferred annuities, the income annuities, and how that affects the annuity you're coming from an annuity that you're going to.
The cost basis of an annuity is the original amount of money you put into the annuity. I’ll give you an example. A guy called me the other day who has a multi-year guarantee annuity and put $100,000 into it. It's now worth $125,000, and he wanted to transfer that non-taxable event to a single premium immediate annuity to provide lifetime income. I told him that the $100,000 cost basis would transfer, even though that total amount will be what he's starting with, with a single premium immediate annuity. Just remember that what you put in, if you transfer to another annuity, will be the cost basis for that new annuity
So when you're cashing out an annuity, like a deferred annuity, the cost basis does play a role. The original cost basis is going to be in place. So when you cash it out, you're going to pay taxes for the last in, first out at ordinary income levels, and the gains are going to be calculated from that cost basis. All right. Let's just say $100,000 is your cost basis, and your account value is $170,000. So in between, there's $70,000 worth of gain. Therefore, when you cash out, it's last in, first out at ordinary income levels, and you're going to pay the taxes on that $70,000 gain.
Let's talk about the cost basis when you're transferring from one annuity to another.
For example, if you have a multi-year guarantee annuity and put $100,000 in, now it's worth $130,000, and you're going to transfer that to another multi-year guarantee annuity. The $100,000 cost basis goes to the new annuity, even though $130,000 transfers. Now, when we're talking about lifetime income, the same thing applies. Let's just say you want to turn that into a lifetime income stream. We can transfer the multi-year guarantee annuity to a single premium immediate annuity (SPIA), a non-taxable event transfer. Under that scenario, the $100,000 cost basis will transfer to the single premium immediate annuity.
Remember, it's now worth 130,000. So you're starting with 130,000 with the SPIA. When annuitizing, the cost basis is spread out over the payments that you're expecting to get, say, over a lifetime. In our business, it's called the exclusion ratio, and you might see that on a Quote.
How Is It Taxed?
So finally, we're going to go through how all of this is taxed. Let's go through the different annuities, like multi-year guarantee annuities. Remember, that's the annuity version of a CD. When you take money out, it's taxed last in, first out at ordinary income levels. With the lifetime income products, depending on what kind of account it's in, it will still be taxed at ordinary income levels. But let's just say, for example, you have an immediate annuity in a non-IRA account. It's a combination of return of principal plus interest. So looking at from a cost basis standpoint, let's say you have 100,000, and it was $130,000 where you started. But the 100,000 was the cost basis, which will be factored into the return of principal plus interest.
In that scenario, you're not going to be paying taxes in a non-IRA account on the return of principal, but you will be paying taxes on the interest, and it's going to be at ordinary income levels. Ultimately, the cost basis details on annuities, whether you're taking money out, just withdrawing it, or annuitizing can be complicated stuff.
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