When people plan for retirement, their attention is primarily fixed upon the total value of their assets. This figure is calculated alongside considerations such as how much income is needed each year, how much longer a person intends to use their money and whether they would like to leave assets to beneficiaries.
Anything from health savings accounts (HSA) to pensions and annuities can be leveraged to provide income over time, but also to be considered is how taxes will impact the total income received. This often overlooked element can be the difference in your standard of living after retiring.
Because they are tax deferred, annuities can be a powerful option when it comes to taxes. Here is what individuals should know about how to defer taxes on an annuity, including what that deferral means for their financial picture and how annuities differ in their taxation requirements.
What Is Tax Deferral?
Tax deferral means that rather than paying taxes every month, year or on another set schedule, taxation only occurs when an individual realizes a gain by receiving it. In order to understand this, consider the standard, non-tax-deferred certificate of deposit.
If an individual contributes money to a CD, they will need to pay taxes each year on the amount that has accumulated beyond their initial contribution. This is new money that they did not contribute and is viewed as income, meaning they owe taxes on it.
However, in a tax deferred situation, taxes are not due on that accumulation until the person receives the money. If the money is dedicated to that product for 10 years, they will only pay taxes at the end of the 10 years when they take the money back—and taxation will only occur on the amount that accumulated, not the original balance.
Tax deferral is a powerful tool to keep more money in your pocket each year and strategically plan how to approach taxes in upcoming years.
Can You Defer Taxes on an Annuity?
In short—yes, annuities function on a tax-deferred basis. This means that regardless of the type of annuity that you select, taxes will be deferred until the accumulation has been collected as income.
However, this can be achieved in multiple ways, each with their own tax implications. Understanding and strategically planning for these outcomes can make a significant difference on long-term financial wellness and success.
Qualified annuities – A qualified annuity is funded with pre-tax money. This is money on which you have not yet paid taxes; it moves directly from the income source to the annuity without being received as income.
Because taxes have never been paid on this money, the entire amount received from the annuity will be taxable once the annuity cashes out. This could occur as a lump sum or over the course of multiple payments for a contractual term.
Non-qualified annuities – When an annuity has been funded with after-tax money, taxes have already been paid on the assets that are committed to the annuity. Thus, when taxes are due after the tax deferral is ended, only the accumulated value will be taxable. This prevents paying taxes on the same income twice.
Calculating Taxation Amounts
When money is received from an annuity, the amount owed in taxes will vary depending on the type of annuity as well as whether the funds were qualified or non-qualified.
Multi-year guaranteed annuities (MYGA), which provide an avenue through which money can accumulate over time without disbursing in payments, will not create a taxable event until the accumulation is received—typically when the MYGA reaches the end of its term, unless it is rolled to another MYGA.
Conversely, annuities that provide regular payments over time can spread the tax burden incrementally across these payments by including a split of post-tax money and accumulated value, making the taxable balance due much more feasible instead of a lump sum.
These details can change depending on how the annuity was funded as well. Those planning for financial wellness into their later years can consider how the annuity type they choose will impact the tax responsibility that they carry when choosing the policy that is right for them.
Choose the Annuity That Best Fits Your Situation
Annuities are flexible options that permit individuals to carefully plan how they would like to approach taxation in their later years. Pillar Life Insurance provides a self-service online portal through which customers can select the annuities that best suit their own goals, risk tolerance, and financial situation.
Get a quote using your personalized information to discover annuities that can help you achieve the financial future that you envision.