TAX CHARACTERISTICS OF ANNUITIES

Nonqualified deferred annuities (NQDAs) are a popular investment vehicle, as they grow tax-deferred.  However, NQDAs come with potentially heavy tax baggage, some of which is obvious, and some not so much.

NQDAs can generate unintended tax consequences during the owner’s lifetime.

• Distributions from the annuity--whether by loan or withdrawal--are taxed on a gain-first basis. 
• BEWARE:  If the NQDA is used to secure a loan, the entire gain portion of the annuity may be taxed right away.
• Taxable distributions from a NQDA may also be subject to an extra 10% tax if they are taken prior to the owner’s age 59 ½.  There are a few special cases in which the 10% penalty tax can be avoided.
• It may be a tax mistake to allow a trust or business to own a NQDA.
• An incorrect beneficiary designation on an older NQDA may generate unintended gift and income tax consequences.

At the death of the annuity owner, a NQDA’s beneficiary may be faced with certain tax decisions.

• If the beneficiary decides to cash in the annuity, that beneficiary will have to pay income taxes on the gain right away.
• The beneficiary may decide to defer paying taxes on much of the annuity value.  Taking advantage of the deferral requires the beneficiary to make the correct choices within a limited period of time.

If you are considering the purchase of a NQDA, here are a few tips:

• Make the annuitant and owner the same, and only implement a different setup after consulting with competent professional advisors and weighing any tax consequences
• Decide at the beginning whether distributions are planned from the annuity, so that the possibility of the 10% penalty tax can be planned for, if needed
• Think carefully about the proper beneficiary designation for the NQDA, balancing potential income tax considerations with family issues
• Take the time and effort to understand the contract provisions of the annuity product that is being proposed, so that there are no surprises later

Even though annuities have some tax issues, annuities are still an excellent tool for saving on a tax-deferred basis.

I hope this information is helpful.

Please contact the Law Offices of William H. Copperthwaite Jr., L.L.C. if you have any questions.

Please note that the information contained in this summary is intended for informational purposes only and is not to be considered tax/legal advice. For specific advice, please contact the Law Offices of William H. Copperthwaite Jr., L.L.C.