Variable annuities are hybrid investment vehicles that allow you to grow your original investment, like a mutual fund does, but also will pay a benefit to your heirs when you die, like a life insurance policy does. When markets are good, your original investment in the variable annuity will grow until you retire or reach age 59 1/2, at which time you can begin withdrawing the money or convert it to a conventional annuity, which pays you a fixed amount each year for a set time period, such as the rest of your life. However, if markets decline, you could end up with an annuity that’s worth less than your original investment. In that situation, the only way to claim this loss on your income tax return is to sell, or “surrender” your annuity.
1. Determine the cost basis of your annuity. This is the amount you originally put into the annuity, minus any withdrawals from the principal you made from the annuity. You should include both your initial investment and any additional investments you made over the years in your cost basis.
2. Figure your loss. Subtract the amount you realized from the sale of the annuity from your cost basis. The company that issued your annuity may charge you a surrender charge – a percentage of the value of the annuity – when you sell the annuity. You may not deduct this charge as part of your loss from your tax returns. Usually, the annuity company deducts this surrender charge from the proceeds of the sale. If you paid a surrender charge, you’ll need to add it back in to reflect the true total you realized from the sale of your annuity.
3. List the loss under Miscellaneous Deductions on your Form 1040. This is line 28 of Schedule A -- Itemized Deductions, of Form 1040 for 2011. You will only be able to deduct the portion of your total miscellaneous deductions that exceeds 2 percent of your adjusted gross income.
- The IRS does not consider a loss from the surrender of a variable annuity as an investment loss, but rather an ordinary loss. IRS Publication 575, Pension and Annuity Income, states “A loss under a nonqualified plan, such as a commercial variable annuity, is deductible in the same manner as a lump-sum distribution.” That is, the loss must be treated as part of your miscellaneous deduction.
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