Fixed immediate annuities will no doubt offer a constant regular income for a definite time-period that can even extend beyond your natural life-time. The choice of how long you wish to avail yourself of these payments can be determined after taking into account your present income and as well as your future money requirements. You may also consider the income needs of your survivor. Lets look at annuities and the annuity tax.
When analyzing the various available payout options, there is yet another point you may have to study - the consequences of the annuity tax to you and your beneficiaries. Because unlike other investments, the annuity tax is more favorable than taxes assessed on other alternatives.
A part of the payments you would receive every year will be a return of your investment that will be tax-free. The remaining part will however be taxed and these amounts may vary for the different payment periods. Assuming you are a 65-year old male, the IRS estimates your life expectancy at 20 years, and you will be offered the following options by an annuity company– let us say on a $250,000 investment:
• A life-only payout stops as soon as you pass away and will provide you around $20,000 per year. Out of this sum, $12,500 of each payment (1/20th of $250,000) will be free from tax and the remaining $7,500 of each payment is subject to annuity tax – resulting in an annuity tax of $1,875 per year if you are in the 25% tax bracket. If you happen to live beyond 20 years, the entire $20,000 of annual income is taxable.
• A life with 20-year assured pays for 20 years or your entire lifespan, whichever is more. You will get around $17,500 every year – of which $12,500 will attract no tax and the balance amount of $5,000 will become taxable, resulting in a yearly annuity tax of $1,250 (assuming you fall in 25% bracket). If you pass away prior to the completion of the 20 year period, your beneficiary will receive the balance of the payments with similar tax treatment as yours, at their tax bracket.
• A 10-year assured annuity will fetch you around $28,500 per year for a period of 10 years with $25,000 as free from annuity tax and the balance $3,500 liable to tax – that will result in annuity tax of $875 for a taxpayer if he incurs the 25% rate. If you die within the stipulated 10 year-period, your beneficiary will get the income for the remaining period in a similar manner.
Please understand that the annuity tax calculations as shown above are only rough estimates for purposes of illustration. They do not indicate any return on a specific investment amount nor takes into consideration the likely impact of charges on the growth or payout. Besides, there are also alternate payout options available – the key issue is how your investment decisions can impact your annuity tax. That way, before investing, you can make decisions, with the assistance of your accountant, on how to minimize your income tax.
You can even look into an annuity ladder for increased annuity tax control.