When planning for retirement, individuals often explore ways to establish steady income. And annuities stand out as a popular choice. But taxes impact all income, including annuities. And annuities and taxes intersect in complex ways which may impact retirement planning. In this blog post, we’ll explore annuities and taxes to help you with your retirement income planning.
What are Annuities?
Annuities are financial contracts between an individual and an insurance company. An individual makes one or more payments to the insurance company. The payments are premiums. And the insurance company gives the individual periodic income payments in return.
Types of Annuities
Now that we’ve covered the basics of annuities, let’s explore the different types.
Fixed annuities guarantee a specific payout and provide predictable returns. Taxation on fixed annuities typically occurs on withdrawal.
Variable annuities are linked to investment accounts. Their returns vary based on market performance.
Indexed annuities are linked to market indexes. These aim to offer potential growth with a level of protection.
Immediate and Deferred Annuities
Annuity payments are divided into two categories, immediate and deferred.
Immediate annuities begin paying income right away, usually within one month of paying the premium.
Deferred annuities begin paying income in the future. This allows time for the money to grow.
Qualified versus Nonqualified Annuities and Taxes
Tax deferred growth is an important benefit of an annuity. This means that taxes are due when you annuitize or begin withdrawing money from your annuity. An important point to know is how you funded your annuity. If you funded your annuity before you paid taxes on the money (pre-tax dollars), you will owe taxes on the entire withdrawal. This is a qualified annuity. But the taxes you will owe will be at your future rate, not at your current rate. While typically, your tax rate is lower in retirement, this is not always the case. Your tax rate will depend on your overall retirement income.
If you pay taxes on the money you use to fund your annuity (after-tax dollars), you will owe tax on the gains you withdraw. This is a nonqualified annuity. The gains may include interest and dividends you earn on your initial contribution. As with a qualified annuity, your taxes will be at your future rate. But unlike a qualified annuity, you will not owe taxes on your initial contribution because you already paid tax on the money.
Impact on Retirement
Taxes significantly influence retirement planning for all income sources, including annuities. And tax efficient strategies can help you keep more money in retirement. Let’s review some strategies for annuities and taxes
Distributions of Annuities and Taxation
Careful planning of annuity distributions can help lessen tax burdens. Optimal withdrawal strategies can help ensure a steady income while reducing the impact of taxes. But remember, timing is key. Careful timing of your annuity distributions can help you manage tax brackets efficiently. By controlling when you receive payments, you can potentially lower your overall tax liability.
Consider Partial Withdrawals
To help control your taxable amount, consider taking partial withdrawals instead of lump sum payments. This approach can help spread the tax burden over several years, potentially reducing the impact on your tax bracket.
Speak with a Professional
Consider seeking guidance from a Financial Advisor or tax professional. Their experience can help aid in creating a tailored tax efficient strategy aligned with your financial goals.
Estate Tax Considerations
Annuities have implications for estate planning. Understanding how annuities affect estate taxes can help aid in devising strategies that aim to reduce the tax burden on your beneficiaries.
Annuities play a significant role in retirement planning because they offer a reliable income source. But annuities and taxes need careful consideration. Being aware of the tax implications can help you decide if an annuity aligns with your financial goals. Consider speaking with a Financial Advisor or tax professional to help you explore annuities and tax efficient strategies that align with your retirement goals.
Want to learn if you are ready for retirement? Take the Retirement Readiness Assessment.
Ready to take control of your finances? Contact me.
Georgene Collins, RICP®, RN, PhD, MBA is a registered nurse turned Financial Advisor at Airey Financial Group. Georgene helps other nurses take control of their finances and prepare for retirement. Georgene began her career with Airey Financial Group in 2017 after retiring from 30 years in healthcare.
Georgene holds the Retirement Income Certified Professional (RICP®) designation from The American College of Financial Services. She holds health and life insurance licenses and a long-term care certificate in Indiana and Illinois. Georgene is a Registered Representative and Investment Advisor Representative and has earned the FINRA Series 63 and 65 registrations.