Annuities are excellent financial planning vehicles. However, when funds are withdrawn, the taxation of a non-qualified annuity is different then other financial investments. Here are some tips to consider.
- Funding: Qualified annuities are often funded with pre-tax dollars, so all of the funds removed from the annuity will be taxable as ordinary income. Roth IRA annuities are not taxable because they are funded with after-tax money.
- Distributions: Qualified annuities are mandatory for a Required Minimum Distribution (RMD). Failure to take a required minimum distribution will result in a 50% IRS penalty. Distributions from a qualified annuity are required by April 1st of the year after you reach 72 in most cases. Of course, the IRS has some exceptions.
- Payouts: You will pay normal income taxes on the entire distribution amount. Annuities purchased with a Roth IRA or Roth 401(k), however, may be tax-free if specific requirements are met.
- Other If you invest in an annuity to fund a retirement plan or an IRA, the annuity will not provide additional tax deferral benefits for that retirement plan or IRA plan.
Taxation of non-qualified annuities
- Funding: Non-qualified annuities are invested with post-tax money and grow tax-deferred.
- Distributions: Non-qualified annuities are exempt from Required Minimum Distribution guidelines. Once you start taking distributions from a non-qualified annuity, any interest or earnings within the annuity will be distributed before the premium or principal amount.
- Payouts: The interest (or earnings) are taxed as ordinary income but you won’t pay taxes on the premium or funds you initially deposited.
Withdrawal If you have invested in a non-qualified annuity, beware of the tax ramifications when you withdraw your funds.