For Mark Roberts’ Use: If you talk to your neighbors, former co-workers, or family members who have already retired, you will notice something that perhaps does not surprise you: There is no single retirement solution that works for everyone! Each decision you make throughout the retirement planning process will ultimately come down to your needs and financial abilities, not what worked for your cousin’s friend’s uncle’s neighbor. But no matter who you are, taxes are inescapable. So as you put together your retirement income plan, make sure you understand the tax implications of each decision you make.
For the purpose of this blog, let’s assume that you’re considering an annuity to provide the income you will need in retirement. Annuities are becoming a popular retirement planning solution these days, but there are a plethora of options from which to choose. One difference between the different types of annuities are their tax structures.
For example, a qualified annuity is usually purchased with pre-tax money. Your employer-sponsored retirement plan or your IRA administrator might offer you this opportunity. You will use pre-tax money to purchase your annuity, but the distributions will be taxed when you begin taking them. If you purchase this annuity within your IRA or employer-sponsored plan, you won’t be reaping any additional tax benefits that aren’t already offered by the plan.
On the other hand, you can also purchase a non-qualified annuity with after-tax money, and outside of your retirement plan. Since you would purchase this annuity with income that has already been taxed, only the earnings within the contract will be taxed later when you begin distributions.
Taxes on non-qualified annuities are based on a “last in, first out” (LIFO) structure. Your withdrawals are first taken from accrued interest, and they are taxed as regular income. After you have exhausted your accumulated interest via withdrawals, all future distributions from the annuity come from your original investment. Since this money was already taxed, it is not taxed again. Essentially, you could say that income from a non-qualified annuity will be taxed in the beginning, but not later. Of course, the timing of that changeover from taxable to non-taxable retirement income will vary according to your annuity contract.
If you have questions about annuities and how they work, call our office to schedule an appointment. An annuity is not right for everyone, but depending upon your circumstances, it could be a good option for you.