Tax Implications of Annuities: What You Need to Know
November 15, 2023 | Kari Mellone
An annuity can be a great way to build wealth and prepare for financial success in the future. One of the most important factors to consider when choosing an annuity is the taxation of the profits you generate from this investment vehicle. Different types of annuities are taxed differently, and this should be part of your consideration when deciding which type of annuity is right for you.
Understanding Annuity Taxation
One of the primary advantages of annuities is their tax-deferral feature. When you invest in an annuity, your earnings grow tax-deferred. This means you won’t pay taxes on the interest, dividends, or capital gains generated by your annuity until you start making withdrawals. With tax-deferred growth, your investment can compound faster compared to taxable accounts, as annual taxes don’t consume your profits.
Different Types, Different Taxation
Two main types of annuities, variable and fixed, are treated differently when it comes to taxation. Fixed annuities are typically taxed as ordinary income when you make withdrawals. Variable annuities can be more complex when it comes to taxation. Earnings from the investments within a variable annuity are taxed as ordinary income when you withdraw; however, if you take out earnings before age 59½, you may incur a 10% early withdrawal penalty.
Qualified vs. Non-Qualified Annuities
Another important distinction in annuity taxation is whether the annuity is qualified or non-qualified. This refers to the money that was used to fund the annuity. Qualified annuities are those purchased with pre-tax dollars, often through an employer-sponsored retirement plan, like a 401(k). Taxes are deferred until you start taking withdrawals in retirement. A non-qualified annuity is funded with already-taxed dollars. Since you have already paid taxes on the money you invest, earnings grow tax-deferred until you withdraw them, and only the gains are subject to taxation.
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Understanding the taxation of annuities is significant when choosing the right annuity and making informed financial decisions. It can be helpful to work with an experienced professional who can provide personalized guidance based on your unique financial situation. A clear understanding of annuity taxation can enable you to make the most of this valuable financial tool to secure your future.
At Twin City Underwriters, we know that individualized attention to a client’s personal situation and needs are especially important, which is why we take the time to understand you and your financial goals. Contact us to schedule an appointment with one of our experienced insurance agents.
Are you ready to have a meaningful discussion about your financial needs? Call or email TCU today to set up a free, no-obligation appointment with one of our dedicated agents.
Call Twin City Underwriters to learn more: 651-488-0172 or 800-507-6778.