Fixed Income Annuity Growth Tax Treatment
Feb 6, 2010 Financial Investment
One of the more common difficulties that people have with their fixed annuities relates to the tax treatment. Although it may seem overwhelming the concept is usually pretty simple to grasp. A fixed annuity is a contract in which the insurance company agrees to make a fixed payment over a specific period of time. The payment is contractual and is based on the premium paid to the insurance company.
One of the more appealing features of an annuity for most people is the option to make it a life annuity. These types of annuities can provide a steady, reliable income for the duration of an annuitant’s lifetime.
Most annuity contract are allowed tax-deferred growth inside of the annuity account, and are taxable upon the payments made to the beneficiaries. On the surface, this tax treatment is straightforward. However, as with most tax problems, the details can get a little complicated.
Tax-deferred growth means that any growth inside of the annuity account is not taxable until it is distributed to the beneficiary. This growth can provide very significant gains to the overall account value.
Each annuity distribution is split into two sections, a taxable section and a nontaxable section. The portion of the benefit that is taxable is dependent upon the exclusion ratio for the annuity. This ratio is calculated by dividing the amount invested in the annuity by the total amount expected to be received. This ratio is then multiplied by each anticipated distribution to calculate the taxable and non-taxable portions of the distribution.
The portion of the contract that is non-taxable is generally the premiums paid, minus the previous non-taxable distributions and minus the value of any period certain or guaranteed features of the particular annuity contract.
Fixed period annuities are normally much easier to calculate the taxes on than are life annuities. The life annuity contracts must use a special table by the U.S. Treasury to determine the life expectancy of the annuitant.
Despite the various disadvantages that fixed annuity contracts have, this type of insurance product can be a very effective retirement planning tool. The lifetime income and ability to preserve capital for the duration of your retirement is a very appealing feature of the product. Add in the various tax advantages, and the fixed annuity can be a quite useful financial planning tool.
Be sure to check out Brian Atkinson at The Fixed Annuity Guide to learn more financial planning topics. The fixed income annuity can be used in creative and powerful ways.
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