How Will My Longevity Annuity Be Taxed?
- Longevity annuity taxation depends on the source of funds used to purchase the policy
- If you purchased a longevity annuity with pre-tax savings, your income payments will be taxed as ordinary income
- If you purchased a longevity annuity with post-tax savings, only a specific portion of the income payments you receive are taxed
A longevity annuity can be purchased with pre-tax money (qualified annuities) or post-tax money (non-qualified annuities). However, qualified and non-qualified annuities have different tax treatment, which affects the income payments you receive.
Like your 401(k) and traditional IRA, qualified longevity annuities also have a tax deferred status. This means that at purchase, you can move funds from your 401(k) or IRA without being taxed or penalized.
Additionally, you don’t pay taxes on your longevity annuity purchase during the deferral period. Since longevity annuities do not have an account value which increases over time (such as with interest), you don’t pay any taxes on interest or earned capital gains.
When your income payments starts in retirement, they will be taxed at regular income tax rates.
Non-qualified longevity annuities are purchased with after-tax money. Like qualified longevity annuities, they won’t be taxed during the deferral period. Also, since they’re purchased with after-tax money, your retirement income will not be 100% taxable. Each income payment can be split into two pieces: a part that’s returning your initial premium, and a part that the insurance company determines is your projected gain or interest earned. Taxes will only be owed on the gain, as the premium you invested in the contract has already been taxed. This non-taxable portion of the income payment is determined using an exclusion ratio (the premium you paid/your expected return), which is provided by the insurance company at purchase.
The exclusion ratio will be applied to each income payment, indicating how much is not taxable, until the full investment in the contract has paid out. Once the investment has been fully returned, subsequent income payments will be fully taxable.
To see how this works, let’s continue analyze Alan’s $100,000 DIA that he’s buying at age 50 with income starting at age 85. Alan will not be using pre-tax retirement savings to buy the longevity annuity, so it’ll be classified as non-qualified. Once Alan starts receiving income at age 85, he’ll have to pay taxes on a portion of the payments.
Longevity annuity rates based on a $100,000 New York Life life-only policy for a male aged-50 with income starting at age 85. Rates as of 10/4/2017.
The exclusion ratio for Alan’s policy is 20%. The insurance company calculated this as the ratio between his investment in the contract ($100,000) and the total amount of income they expect to pay him ($490,000 in this case). Thus 20% of his income payments will be excluded from his taxable income until a total of $100,000 has been excluded. For Alan, this will be the case once he’s received 7 years worth of payments, after which the longevity annuity income will be fully taxable at ordinary income rates.
There’s one last bit! When you purchase a longevity annuity, you have the option to add a beneficiary. This means that your beneficiary will receive the difference in premium paid and income received, if there’s any remaining. If your beneficiary chooses to annuitize that remaining premium (instead of receiving it all at once), that income will be taxed at the regular income tax rate. This doesn’t apply if the payout is coming from a non-qualified annuity where the money was taxed
Disclaimer: This article is provided for informational purposes only and not for the purpose of sales, solicitation or inducement to purchase any annuity product. Blueprint Income is not responsible for the accuracy of this information. If you wish to confirm the information contained herein, prior to making an annuity purchase, please consult with your tax advisor.