Seeking Safety with Annuities

The decision to invest in an annuity should be made carefully and with the help of your trusted financial team. Due to the market decline and economic downturn, annuity investments have found favor in the eyes of many investors who see the possibility of outliving their retirement savings, especially without a strong recovery and/or the emergence of another market decline. The quick and dirty of an annuity arrangement is that an individual makes a lump-sum or other front-loaded investment, in exchange for periodic payments starting at a certain date. There are a number of options as to how you can have your annuity structured, so contacting a professional is suggested if you are considering an annuity as the right investment choice for you.

Today, we’re going to focus on the tax nature of annuities and how they can be a piece of your retirement planning.

As with all investment vehicles, the taxation of the vehicle will depend on what “garage” you decide to hold it in. As we previously discussed, there are really two options here and that is to hold it outside of a traditional tax-favored retirement account or to hold it inside such an account, i.e. Traditional IRA. The decision where to hold your annuity investment is important and should be considered with your Financial Planner and CPA. These are some factors to consider when making this decision:
• Tax rates on income generated by the investment
• Ability to Defer Income
• Future tax rates
• Flexibility needed to use funds

Generally, a distribution from an annuity is subject to ordinary income tax. However, any individual who receives an annuity payment will have the ability to exclude part of the payment from their gross income. The reason behind this is that a portion of each payment is considered to be a return on capital (your initial investment). The exclusion amount is calculated via a formula that multiplies the annuity amount received by the exclusion ratio. The exclusion ratio is calculated by dividing the investment in the annuity by the expected return under the annuity.

If an annuity is held in an IRA, remember a few key taxation points:
• To the extent allowed by law, if you make a Annuity contribution to your Traditional
IRA, it is tax deductible. Contributions made directly to annuities, outside of IRA’s, is
not tax deductible. The key here is whether or not you are eligible to make tax
deductible contributions to an IRA.
• Be careful or the contribution limits associated with IRA’s and how this will affect how
much you can fund your annuity held in an IRA.
• RMD at age 70 ½: For an annuity held in an IRA, the owner will be required to start
taking distribution in the year in which they reach age 70 ½. This is not the case if you
hold your annuity outside of an IRA structure.

Next week, we will continue talking about retirement vehicles and tax issues related to them. On the docket is 401(K) plans and some offshoots that are inevitably encountered by some of our readers. W-2’s, 1099’s, etc. should be in, so remember, it’s never too early to start your tax work!