Many of your clients may face uncertainty about whether they should claim various investment income on their taxes and, if so, how. This is especially true in light of recent tax code changes signed into law — the first major revisions since 1986.1

Retirees who rely on income from tax-deferred annuities may be affected by changes to tax rates, brackets, deductions, and exemptions. Here, we’ll share a general overview of how qualified and non-qualified annuities are taxed along with some considerations for helping your clients to manage their investments.

Annuities are Tax-deferred, Not Tax-free

Misconceptions about annuities aren’t uncommon. While some annuities are often promoted as being tax-deferred, it should never be implied that these investments are a way for retirees to avoid paying taxes all together. Once an investor begins withdrawing earnings or lump sum distributions from an annuity, a portion of those withdrawals will be taxed as regular income based on how the annuity was structured to begin with.

Investment gains on fixed or variable annuities over and above the initial contributions must be withdrawn first, and those earnings are considered taxable income. Once investors begin withdrawing from their cost basis, the income is generally not considered taxable.2 Qualified and non-qualified annuity payouts are taxed differently, however.

Qualified Annuity Taxes

Qualified annuities are funded with money that hasn’t been taxed prior to placing it in the investment (pre-tax). Your clients can choose to deposit or rollover a tax-deferred 401(k) or IRA directly into a qualified annuity, for example. Because these contributions weren’t taxed to begin with, however, they will be fully subject to the owner’s ordinary income tax rate (rather than the capital gains rate) upon withdrawal in addition to taxes on any subsequent earnings.3