Maximizing your own savings to ensure you have an income in which lasts a lifetime is possible using a retirement annuity. If leaving behind a legacy of cash for your family is not a huge concern, then a retirement annuity is just what you'll need. This ensures an additional income for your lifetime, with the amount depending on your age, gender and investment amount.
How is a Retirement Annuity Taxed?
For a single payment retirement annuity, you receive a fixed monthly income that never changes (unless you opt for the COLA rider). This additional regular monthly income that you enjoy includes a substantial untaxed amount, which is what IRS calls the "basis", in this case, the purchase price. This basis is actually a fraction of each payout, and that fraction is called the exclusion ratio. The exclusion ratio (the portion of each annuity payment that is return of principal and untaxed) is a fixed percentage of the purchase price to the anticipated total payout.
Let's use an case in point to understand how this annuity tax operates. A 65-year-old male, residing in Sacramento CA, opts for a $100,000 retirement annuity to be paid out over a period of 15 years.
His selected annuity company offers $617 per month. Note that at the end of 15 years, the retirement annuity will be exhausted with no balance left for the investor or his heirs. The total payout over a period of 15 years at $617/month is $111,060. Which means, the exclusion rate is an astounding 90% (= $100,000/$111,060).
The annual income from a $100,000 retirement annuity is $7,404 ($617 monthly times 12 months). Out of this, a meager $740 is taxable. Assuming a25% marginal tax rate, would mean total tax of $185, leaving you $7,219 to spend. Consider the alternative investment involving $100,000 in corporate bonds at 5%.
As an investor, you would earn $5,000 in total yearly income. Additionally, the complete amount would be taxable at the 25% rate, bringing your spendable income down to $3,982. This is about half of what your retirement annuity offers you. "Wait a minute," you say. The retirement annuity exhausts my principal and the corporate bond does not. Agreed. However, if concerned with your own circumstances (not your heirs circumstances) and that fact that money is worthless to you when dead, does the fixed income from the retirement give you a more secure, known amount you can rely on? In another post, we will see that a retirement annuity, when selected for a lifetime annuity income, is more compelling than one which pays for a set period of time.
Reduced Tax on Social Security Benefits
In case of single retired individuals, provisional incomes of over $25,000 will cause social security payments to be taxed . While, for a couple that files their taxes jointly, the provisional income exceeding $32,000. Provisional income is the term used by the IRS to determine the threshold over which social security income is taxed. The actual provisional income includes 50% of the social security income and a tax free interest income. Provisional income of over $34,000 and $44,000 may lead to as much as 85% of benefits being taxed.
As far as retirement annuity is involved, because only a small portion of your income received is taxable and is exempt from the provisional income, retirement annuities (or any type of annuity) can help you save tax on social security benefits. According to the example above, your retirement annuity income adds only $740 to the provisional income. With the corporate bonds, it is up to $5,000 from 5% bonds. If you happen to be in close proximity to or within the threshold amounts mentioned above, a retirement annuity can bring tax savings. Thanks to your retirement annuity, larger amounts of your social security continue to be untaxed. These tax savings can add substantially to your overall annuity return.