How Are Qualified Annuities Taxed?

Taxes, taxes, taxes. The question is, how are Qualified Annuities taxed? Meaning that you have an annuity inside of your IRA; how are those annuities taxed? We'll talk about that. But disclaimer, do not take tax advice from agents and advisors and people who haven't gone to law schools, gotten tax degrees or CPAs, and passed courses for tax advice. That includes Stan The Annuity Man. I'm going to talk about that under the auspices that you're smart enough to, if you got tax questions, actually have them sign off on them, meaning the lawyer and the CPA.

The Taxing Inside and Outside an IRA

We're going to talk about the taxation of annuities inside of an IRA, and I'll briefly go over the taxation of annuities outside of an IRA too, so you have a good feel for how that all works. So, let's talk taxes. Hang in there, tax man. An IRA, qualified, when we're talking about qualified money, your IRA, 401(k), qualified, it's been tax-deferred forever. Any money you take out of your traditional IRA, and let's talk about your traditional IRA, which is the qualified account. I don't care what you have it in, stocks, bonds, whatever. Whatever you take out, you must pay taxes on it at ordinary income levels. That's just the way it is.

Same thing with any type of annuity, whether it's an annuity that you're deferring, that's growing like a Multi-Year Guarantee Annuity. Or if it's an income-type annuity like a QLAC, a Qualified Longevity Annuity Contract, or an Immediate Annuity. Any money coming out of that IRA is going to be taxed. Period.

Some people don't even know you can put annuities inside an IRA. And the vast majority of annuities that are owned in this country are inside IRAs because that's where the vast majority of the money in this country is, trillions and trillions and trillions and trillions and trillions of dollars. One of the things about a Multi-Year Guaranteed Annuity, which is a Deferred Annuity that people use outside of an IRA, is it grows tax-deferred, and you ought to pay taxes on it. But inside of that IRA, it doesn't matter, and you're not going to get double tax deferral.

Anytime you're looking at your IRA as the house and what you have inside of it, the investments inside it, whatever they are, mutual funds, bonds, stocks, annuities, whatever, all the rules go away. The only rule that applies is the IRA rule of when you take money out, it's going to be taxable. So, remember that.

Example

I got a call the other day, and the guy said, "Hey, I've got money in both IRA and non-IRA accounts. Where should I put this investment?" And first of all, I asked him the two questions, "What do you want the money to contractually do, and when do you want those contractual guarantees to start?" He and his spouse needed income now, like right now, and that's an Immediate Annuity, a Single Premium Immediate Annuity. So, we started talking about where you put it. Do you buy the Immediate Annuity inside the IRA, or do you buy the Immediate Annuity outside the IRA?

Once again, there are no perfect answers, just bad sales pitches. We went through the positives and the negatives of both. Let's do that, and let's go through the conversation I had with him because it might apply to you.

If he were to buy the Immediate Annuity inside the IRA, all that income coming out would be taxable at ordinary income levels. Now, outside of that IRA, if you bought the Immediate Annuity, remember it's a combination of return of principal plus interest based on your life expectancy at the time of the payment, so he's not going to pay taxes on the return of principal, just the interest.

The income stream coming out of the non-IRA setting was slightly more favorable from the standpoint of real-value money because only a portion was being taxed. But the one in his IRA, the Immediate Annuity, if he were going to buy this IRA, would be all taxable. So he goes, "Stan, that's just kind of a no-brainer, and we put it all there." Hold on there Chester, because there are reasons to put an Immediate Annuity in an IRA even though you're not taking advantage of what's called the exclusion ratio. And here's why. Suppose you buy an Immediate Annuity inside of your IRA, and you take income from that Immediate Annuity. In that case, that income stream fully covers your Required Minimum Distributions for that dollar amount in the Immediate Annuity. Does that make sense? Let me put it another way.

Suppose you had $500,000 in your IRA and bought a $200,000 Immediate Annuity. That income stream coming from that Immediate Annuity is going to cover the Required Minimum Distributions when you turn 70 and a half. Of that $200,000 asset, then you'd have to take additional requirements and distributions of that additional 300 non-annuity asset. So, what happened at the end of the day to, let's call him Chester because I love that name. What happened to Chester at the end of the day? Split the money. He said, "I kind of like the RMD thing because that's going to cover some of that for me, and I don't have to worry about it." He did half of the money in the Single Premium Immediate Annuity in the IRA and the other half of the out amount in the non-IRA setting, so he could take advantage of a little bit more of the income from a taxation standpoint and was happy.

The Bottom Line

The bottom line is there's no perfect answer to where to put annuities. What account makes sense? What you're trying to achieve makes sense, and you understand the full rules, benefits, and limitations. It's all you baby boomers out there, all you people that have just been working to death, working so hard over these decades, and you've accumulated all this money in your IRA, or you've taken your 401K and rolled it into an IRA. What do you do? "Stan, if I decided to put an annuity in that IRA, how are they taxed?" Just remember that anything coming out of that IRA will be taxed. Period. But that's okay. And just as I explained in that previous story about the client that bought an Immediate Annuity inside of the IRA, it covers the Required Minimum Distributions for that asset.

So, there are some positives. Look at always buying annuity for what they will do, not what they might do and the contractual guarantees. Inside of an IRA, you're putting the annuity inside of that IRA, that qualified account for the contractual guarantees. If it makes sense, contractually, it'll make sense in your IRA.

Don't be bamboozled by some pie-in-the-sky unicorns chasing the butterflies' nonsense sales pitch, okay? Understand the contract. And I'll send these to you. Now, first of all, I need you to hit the subscribe button. Please do. Putting out videos all the time, and I'm talking about every day, Monday through Friday, there's a new one coming out, we are busy. We're committed to this education thing.

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