Annuity Taxation

You should consult your tax professional for complete information regarding annuity taxation. Following is a basic summary of certain tax considerations of which you should be aware.

  • A qualified annuity is taxed identically to any other qualified account such as an IRA, 401(k), profit sharing plan or other tax-deferred retirement account.

Nonqualified annuities are taxed differently from most investments:

  • A nonqualified variable annuity grows tax-deferred until withdrawals begin or the policy is annuitized.
  • A nonqualified annuity does not provide a step-up in cost basis at death, and the deferred earnings will be taxable as ordinary income to a non-spousal beneficiary.
  • Spousal continuation of the policy may be available to preserve continued tax-deferred growth.
  • An annuity is included in your estate for estate tax purposes.

Withdrawals – Withdrawals of earnings from a nonqualified annuity are fully taxable at ordinary income tax rates. Unless the annuity was purchased before August 14, 1982, the earnings are considered withdrawn first and are therefore subject to taxation. All withdrawals will be fully taxable as ordinary income until the account value reaches the initial amount invested. Because annuity income is taxable at ordinary income tax rates, you do not receive the benefit of lower capital gains tax rates. Also, if you are under age 59 1/2 when you make the withdrawal, you may be assessed a 10% penalty on any taxable earnings.

Annuitized Payments – If you annuitize a nonqualified annuity, a portion of your payment will be considered a return of premium and will not be subject to ordinary income tax. The amount that is taxable will be determined at the time you elect to annuitize the policy. A calculation will be made by the insurance company to determine the “exclusion ratio,” which will determine the percentage of each payment that will be excluded from income tax.

Taxation at Death – Spousal Continuation – Many variable annuities enable your spouse to continue the policy at your death. Some companies will pay the death benefit into the policy and continue the original policy without tax consequences. Others will require your spouse to choose either the death benefit (if the account value is lower than the death benefit) or spousal continuation. Choosing the death benefit in these situations would be a taxable event; your spouse would be taxed at ordinary income tax rates on the difference between the death benefit and the amount you invested, adjusted for any withdrawals. In most cases, the policy would not be included in your taxable estate for estate tax purposes due to the marital allowance. You should consult the prospectus for the terms of spousal continuation.

Taxation at Death – Non-Spousal Beneficiary – At your death, the death benefit will be paid to the non-spousal beneficiaries you have designated. By doing so, the transfer will avoid probate. Unlike most other securities, there is no step-up in cost basis at your death. Instead, any deferred income in the policy will be taxable to the beneficiaries as ordinary income at their tax rates. If a death benefit is paid out that is higher than the account value, the difference between the death benefit and the amount you invested, adjusted for any withdrawals, will be taxable as ordinary income to the beneficiaries. The value of the variable annuity policy also will be included in your estate for estate tax purposes. Beneficiaries have the choice of taking a lump sum payment or receiving the payments over a period of time, thereby spreading out the income tax liability.

For more information, please contact your local financial advisor.

Edward Jones, its employees and financial advisors are not estate planners and cannot provide tax or legal advice. Please consult your attorney or qualified tax advisor regarding your particular situation.

Edward Jones operates as an insurance producer in California, New Mexico and Massachusetts through the following subsidiaries, respectively: Edward Jones Insurance Agency of California, L.L.C., Edward Jones Insurance Agency of New Mexico, L.L.C. and Edward Jones Insurance Agency of Massachusetts, L.L.C.

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