Annuities are one class of financial products that many people choose to use to fund their retirement or help them prepare for greater financial wellness. However, while it may seem simple enough to contribute money to an annuity and then let it pay out or accumulate over time, what’s not usually as clear is how this money is taxed—if at all.
Understanding the role your annuity plays in your annual tax burden can help you make smart choices, not only in budgeting, but also in how to receive your income so that you decrease your taxable income as much as possible. Here are the basics of taxes on annuities to get you started.
Is Income from an Annuity Taxable?
In short—yes, most of the time, some or all of what you receive from an annuity will be taxable. However, there are a lot of variables that will impact exactly how much this tax will be.
The good news is that, as the person who is selecting the annuity, you have control over a significant portion of this process. Your selections on how to fund the annuity and how to receive the money later will be the primary determiners of how much taxable income you will generate.
How Are Annuities Taxed?
The question “how are annuities taxed?” does not produce one simple answer. Instead, taxation can vary based on the type of annuity and even how you choose to receive income from it. First, you will need to think about qualified and non-qualified annuities.
Qualified annuities are those that are funded with before-tax money. For example, you can choose to invest in an annuity within some 401(k) plans, to which you may contribute pre-tax money. Since this income has not been taxed yet, it will be taxed as income (along with any growth) when you receive the money from the annuity.
Non-qualified annuities are funded with after-tax money. Since you have already paid income taxes on these funds, you will only need to pay additional tax on any of the accumulation within the annuity.
Knowing this, you can be strategic about how you will be taxed based not only on the type of annuity and funding method that you choose, but also how you receive your income. If you choose to take a lump sum, your taxes will be higher than if you break those taxable events across smaller payments over multiple years.
The Benefits of a MYGA Against Taxation
Every type of annuity will produce slightly different results, but few stand up to taxation as well as a MGYA. Multi-year guaranteed annuities are a tax-advantaged vehicle. This means that you won’t need to pay any taxes at all for the entire time that your balance is growing.
Compare this to a CD (certificate of deposit) or similar product that will require you to pay taxes each year on the growth. MYGAs allow more of your money to grow over time before taxes so that your balance can climb as high as possible.
However, be aware that MYGAs are vehicles for growth; they are intended as a place to put your money and leave it untouched for multiple years. At the end of the MYGA term, you can elect to roll the annuity into another MYGA (which can be done without creating a taxable event), accept the money as a lump sum or even move the money into a fixed annuity to begin receiving payments.
Reporting Taxes When You Have an Annuity
No matter what type of annuity you determine is right for your situation, you will still need to pay taxes on at least some of it eventually. In order to do this, you will need to file a 1099-R form with your taxes.
Your annuity provider should give you a copy of your 1099-R each year that lists the distributions that you received from any annuities. If you have more than one annuity, you will receive a 1099-R for each of them. However, if you only receive $10 or less in distributions, you will not be required to file this form with your taxes.
Choose the Annuity That’s Right for Your Long-Term Goals
Annuities can be a helpful part of your complete financial picture, but you should be sure that you are paying the appropriate taxes on them to avoid an unexpected tax bill later. The good news is that with a variety of annuities to choose from, you can make the decision that is best for your situation.
That’s why Pillar Life Insurance puts the power in your hands to select annuities without the need to speak to an agent. Take a look at our online portal and fill out a questionnaire to get started.
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