How Are Annuities Given Favorable Tax Treatment?

Shawn Plummer

CEO, The Annuity Expert

When saving for retirement, most people consider contributing to a 401k or IRA. However, other options are also available, and one of the most tax-friendly is annuities. In addition, annuities offer several benefits that make them an attractive option for retirement savings. This guide will discuss how annuities are given favorable tax treatment and why they might be a good choice for you!

Favorable Tax Treatment For Deferred Annuities

Annuities receive favorable tax treatment by deferring taxes to make retirement savings grow faster and allow the ability to contribute more than the standard annual amount on a qualified retirement plan such as a 401(k) or IRA.

These annuities are tax-advantaged because their interest earnings accumulate on a tax-deferred basis. While no taxes are levied during the accumulation phase, taxes must be paid when the contract begins to pay out its benefits.

The Internal Revenue Code includes penalties and taxes on early withdrawals and loans to discourage investors from utilizing deferred annuities as short-term investments.

Withdrawals are classified as earned income and are taxed as ordinary income.

Additionally, a 10% early withdrawal penalty tax is imposed on withdrawals from a deferred annuity before age 59½. 

Favorable Tax Treatment For Annuitization

The IRS calculates how much of an annuitized non-qualified annuity withdrawal is taxable. This calculation is called the exclusion ratio. This ratio calculation is based on the length of the annuity, the principal, and the earnings.

If a non-qualified annuity is set up to pay the owner annuitized annuity payments for their entire life, the exclusion ratio will consider their life expectancy. If they live longer than their calculated life expectancy, all annuity payments beyond that time period are taxed as income.

Favorable Tax Treatment For Long-Term Care Expenses

In addition to tax-deferral, certain fixed annuities (long-term care annuities) can be used as long-term care insurance providing income tax-free withdrawals for qualified long-term care expenses.

Next Steps

Annuities can be a great way to save for retirement, thanks to their favorable tax treatment and other benefits. If you’re interested in learning more about annuities or want help setting one up, please visit us! We have experts on staff who can answer any questions you may have and help you get started on the path to a secure retirement. Thanks for reading!

How Are Annuities Given Favorable Tax Treatment?

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Shawn Plummer

CEO, The Annuity Expert

I’m a licensed financial professional focusing on annuities and insurance for more than a decade. My former role was training financial advisors, including for a Fortune Global 500 insurance company. I’ve been featured in Time Magazine, Yahoo! Finance, MSN, SmartAsset, Entrepreneur, Bloomberg, The Simple Dollar, U.S. News and World Report, and Women’s Health Magazine.

The Annuity Expert is an online insurance agency servicing consumers across the United States. My goal is to help you take the guesswork out of retirement planning or find the best insurance coverage at the cheapest rates for you. 

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