How To Calculate Taxable Income On An Annuity

Annuities and Taxes

So, how do you calculate taxable income on an annuity? It's very important for you to understand the taxation of annuities. You can use our proprietary calculators to run quotes on your own terms and timeframe with absolutely no sales pitch.Annuities and Taxes

What is the taxable portion of an annuity? How are withdraws from annuities taxed? How is annuity income reported? You know, the IRS? So when we're talking about how to calculate taxable income on annuities, I'm assuming you have a life. I'm assuming there's more to life than just talking about taxes and reading the IRS tax code. We're going to talk about all the details in life only and exclusion ratio and all this stuff and all the annuity speak and the annuity language that everyone uses.

So when you're calculating taxable income on an annuity, it depends upon the annuity type. It really is broken down into two types of annuities when you're talking about income. You have the annuitization type products, Single Premium Immediate Annuity, Deferred Income Annuity, and Qualified Longevity Annuity Contract. Those are what I call annuitization products. Think about this. It's like ripping the knob off of a water faucet. Water's going to flow. With the annuitization products, SPIAs, DIAs, and QLACs, once you turn on the income, that income are going to flow, okay? It's an irrevocable income stream.

Income Riders

Now, the other type of annuity income guarantee you need to be aware of is what's called an income rider, and an income rider can be attached to a deferred annuity-like an indexed annuity or a variable annuity. It's a separate calculation, and the majority of income riders are what's called withdrawal products. They're not annuitized. They are a lifetime income stream guarantee, but you're withdrawing from the policy, and you're going to get paid for the rest of your life. So those are the two types: annuitization and withdrawal. SPIA, DIA, QLAC, income rider.

Calculating the taxable income on your annuity really comes down to the type of account the annuity is inside of. So if it's an IRA, a traditional type IRA, all of the money coming out of that IRA is taxable because you've been deferring. If it's a non-IRA account, a non-qualified account, as they say, you're going to pay taxes on the interest. And if it's a Roth IRA, it's tax-free.

Only take tax advice from a tax lawyer and a CPA.

Taxes on Withdrawals

All right, so the taxes on your annuity also depends on how you take it out. So there are a couple of ways. Annuitization is the annuitized products like Single Premium Immediate Annuities, Deferred Income Annuities, and Qualified Longevity Annuity Contracts. Now, when that income starts, it's a combination of return of principal plus interest. So every single payment is going to have the return of principal plus interest.

For example, in a non-qualified or non-IRA account, you’ll pay taxes on the interest, but when the account goes to zero, you’ll still get a lifetime income stream. And then all of that money after the account's at zero will be taxable. So let's talk about income riders. Income riders, that income will be taxed last in, first out, LIFO gains first. So you’ll pay taxes on that income stream until you reach the principle. Once you reach the principle, then that income stream is still coming. You're not going to pay any taxes. Once the account's at zero, then that income stream continues, and it's all taxable.

So when calculating the taxable income on your annuity, it's common sense that you’ll pay less if you're in a low tax bracket. If you're a high roller in a high tax bracket, you will pay more taxes. Seems fair, right? Also, understand that all annuity income is reported as ordinary income, and our friends will issue a 1099 at the IRS. And yes, they are our friends.

What I'm getting ready to tell you is very important. So listen, lean in. Never take tax advice from an agent or advisor unless they're a CPA or a tax lawyer. Only take tax advice from a tax lawyer and a CPA.

Never forget to live in reality, not the dream®, with annuities and contractual guarantees! You can use our calculators, get all six of my books for free, and most importantly book a call with me so we can discuss what works best for your specific situation.