Tax Rules for Fixed Annuities

by Gregory Gambone, studioD

If you own a fixed annuity, or are considering investing in one, you must become familiar with the tax treatment of these types of accounts. Since annuities are retirement investment vehicles, specific IRS regulations affect contributions, accumulation, withdrawals and taxation of these accounts. The specific type of annuity you own, whether it be fixed, variable or indexed, is irrelevant as far as how these rules are applied and the tax treatment of these products.

Qualified Contributions

Deposits into qualified annuities may be deducted on your income taxes. The specific account within which the annuity is held determines how much you can contribute and deduct in a year. The entire balance of the annuity accumulates without tax liability until you actually withdraw it when you retire. If your annuity is within an IRA, you may contribute up to $5,000 unless you are over age 50,

Non-Qualified Contributions

Contributions into non-qualified annuities do not result in an income tax deduction. Money deposited into these non-qualified accounts comes from your existing personal savings. Typically, the insurance companies maintaining annuities do not impose limits on how much you may contribute. Any growth within an annuity will remain untaxed until you withdraw it. Regardless of how much you deposit and how much growth is inside your fixed annuity, taxes are deferred, allowing more of the money to continue working toward further growth.

Qualified Withdrawals

Withdrawals from annuities held within qualified retirement accounts like IRAs and 401ks are fully taxable. Since none of the money in these annuities has been taxed yet, any funds distributed result in an increase of your taxable income for that year. IRS regulations require that money held within qualified retirement plans, including funds inside fixed annuities, remain in those accounts until you reach age 59 1/2. Once you reach this designated age, you are free to withdraw the money without penalty or further explanation.

Non-Qualified Withdrawals

Withdrawals from non-qualified annuities only result in an increase to your taxable earnings for the year if your account value is larger than the total aggregate sum of your deposits. Since fixed annuity contracts are not subject to market risk and your account value will not decrease during economically volatile times, your account value will undoubtedly be larger than the sum total of your contributions. The IRS employs the last-in-first-out (LIFO), methodology to determine the taxable portion of non-qualified annuity withdrawals, which means that every dollar of your distributions is fully taxable until the total withdrawn exceeds the growth and begins to include your original principal.

About the Author

Gregory Gambone is senior vice president of a small New Jersey insurance brokerage. His expertise is insurance and employee benefits. He has been writing since 1997. Gambone released his first book, "Financial Planning Basics," in 2007 and continues to work on his next industry publication. He earned a Bachelor of Science in psychology from Fairleigh Dickinson University.

Photo Credits

  • Comstock Images/Comstock/Getty Images