Are Annuity Payments Taxable?

Shawn Plummer, CRPC

Chartered Retirement Planning Counselor

Qualified Annuity Payments

  • Source of Funds: Funded with pre-tax dollars, typically from retirement accounts like 401(k)s or IRAs.
  • Taxation: Entire payment is taxable as ordinary income since contributions were tax-deferred.
  • Withdrawal Age: Tax penalties may apply if withdrawals are made before age 59½.

Nonqualified Annuity Payments

  • Source of Funds: Funded with after-tax dollars.
  • Taxation: Only the earnings portion of the payment is taxable.
  • Exclusion Ratio: Used to determine each payment’s taxable and non-taxable portions.
    • Calculation: Total investment in the contract divided by the expected return.
    • Purpose: Ensures the return of principal is received tax-free over the payment period.

LIFO for Guaranteed Lifetime Withdrawals on Income Riders

  • LIFO (Last-In, First-Out) Method: Applies to certain nonqualified annuities with income riders offering guaranteed lifetime withdrawals.
  • Taxation: Initial withdrawals are considered earnings (last in) and are taxed. Once earnings are exhausted, withdrawals are considered a return of principal (first in) and are non-taxable.

Taxation of Annuity Payments

Type of AnnuitySource of FundsTaxation of PaymentsSpecial Considerations
QualifiedPre-tax dollarsFully taxable as incomeEarly withdrawal penalties
NonqualifiedAfter-tax dollarsOnly earnings are taxableExclusion ratio applies

Conclusion

Understanding the tax implications of annuity payments, whether qualified or nonqualified, is crucial for effective financial planning. The exclusion ratio for nonqualified annuitized payments and the LIFO method for income riders greatly influence how annuity payments are taxed. This knowledge ensures that individuals can make informed decisions about their retirement income. Contact us today for a free quote.

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Questions From Our Readers

How do I figure out the taxable portion of my annuity?

To figure out the taxable portion of your annuity, you’ll need to know whether your annuity is qualified or non-qualified, as this affects how the taxes are calculated. For a non-qualified annuity, the investment is typically made with after-tax dollars, so only the earnings part of your withdrawals is taxed. You can use the exclusion ratio to determine this; it’s a method that splits your payment into a non-taxable return of your principal and a taxable income portion. For a qualified annuity, funded with pre-tax dollars (like from an IRA or 401(k)), the entire withdrawal amount is generally taxable as ordinary income.

Can I deduct annuity fees on my taxes?

Generally, annuity fees are not deductible on personal income tax returns. If the annuity is part of a qualified retirement plan like an IRA, you may effectively get a deduction since contributions to these plans are often tax-deductible. However, the fees themselves are not separately deductible. For non-qualified annuities, fees do not qualify for tax deductions.

Shawn Plummer, CRPC

Chartered Retirement Planning Counselor

Shawn Plummer is a Chartered Retirement Planning Counselor, insurance agent, and annuity broker with over 14 years of first-hand experience with annuities and insurance. Since beginning his journey in 2009, he has been pivotal in selling and educating about annuities and insurance products. Still, he has also played an instrumental role in training financial advisors for a prestigious Fortune Global 500 insurance company, Allianz. His insights and expertise have made him a sought-after voice in the industry, leading to features in renowned publications such as Time Magazine, Bloomberg, Entrepreneur, Yahoo! Finance, MSN, SmartAsset, The Simple Dollar, U.S. News and World Report, Women’s Health Magazine, and many more. Shawn’s driving ambition? To simplify retirement planning, he ensures his clients understand their choices and secure the best insurance coverage at unbeatable rates.

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

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