How much tax do you pay on an annuity withdrawal?
Like qualified annuities, withdrawing money from a nonqualified annuity before age 59½ may result in owing a 10% early withdrawal federal tax penalty and income tax on the earnings. However, the penalty applies only to the taxable portion of your withdrawal—not your tax-free return of principal.
Annuities are taxed when you withdraw money or receive payments. If the annuity was purchased with pre-tax funds, the entire amount of withdrawal is taxed as ordinary income. You are only taxed on the annuity's earnings if you purchased it with after-tax money.
- Determine the cost basis.
- Divide your cost basis by the accumulation value to get the exclusion ratio.
- Multiply your monthly payout by the exclusion ratio.
- Subtract the excluded portion from the total payout.
To avoid paying taxes on your annuity, you may want to consider a Roth 401(k) or a Roth IRA as a funding source. Then, you do not pay taxes upon withdrawal since Roth accounts are funded with after-tax dollars.
Many annuity contracts also let the owner withdraw up to 10% of the contract value or premium each year, as defined in the contract, penalty-free.
If the insurer can expect to receive a 7 percent return on its $50,000, the monthly payout would rise to $449.96. At a 3 percent return, the payout would drop to $327.05. Insurers base their anticipated return on the performance of their often-conservative investment portfolios.
For instance, a $100,000 annuity purchased at age 65 with immediate payments might yield about $614 monthly. If the annuity has a 5% interest rate over 10 years, the monthly payment could be approximately $1,055.. At age 70, the same annuity might pay around $613 monthly for life.
If you take a lump-sum distribution, even using Form 4972, the retirement plan administrator typically withholds 20% of your withdrawal and sends it to the IRS on your behalf. If your ultimate tax liability is lower than 20%, you can claim that part back when you file your taxes.
The amount of each payment that is more than the part that represents your net cost is taxable. Under the General Rule, the part of each annuity payment that represents your net cost is in the same proportion that your investment in the contract is to your expected return.
The annuity exclusion ratio tells you how much of your annuity returns you'll have to pay taxes on. You don't pay taxes on your principal, so the annuity exclusion rate is calculated by dividing your principal paid by your expected return.
How do I get out of an annuity tax free?
And to avoid the IRS tax penalty, make your annuity withdrawal after age 59½. Of course, the best way to avoid penalties is to avoid early withdrawals entirely. If you purchase an annuity, wait out the surrender period and, if you are over age 59½, choose annuitization .
The five-year rule lets you spread out payments from an inherited annuity over five years, paying taxes on distributions as you go. You take the remainder of the contract and stretch annuity payments out over the rest of your life. Your life expectancy sets the basis for your actual payment amount and schedule.
Because the annuity owner invested after-tax dollars, the principal isn't taxed when distributed as a death benefit. Therefore, beneficiaries will only pay taxes on the earnings. Earnings are taxed as ordinary income and don't receive any special capital gains treatment.
Often, having an annuity means paying high management fees, high taxes, and a commission fee for setup. Cashing out part of your annuity can mean having money on hand for big expenses. Opting for a lump sum cash for your annuities may be one of the smartest decisions you can make for yourself.
Closing or cashing out an annuity altogether—simply pulling out all your money and shutting down the contract—is an option if you need all of the funds. However, this process may also come with surrender charges, tax implications and the 10% federal tax penalty.
Surrender Fees for Cashing In an Annuity
You pay a surrender charge if you withdraw money from your annuity before the surrender period is up. Typically, it's around 7% of the amount you withdraw. The amount of the penalty decreases over time once the surrender period expires.
The table below, an example intended for illustrative purposes, shows that, in exchange for a $100,000 premium, a 65-year-old could receive $7,518.96 annually in guaranteed lifetime income—a 7.5% payout rate.
| Age | Single Life Only | Single Life + 10-Year Certain |
|---|---|---|
| 80 | $1,945 | $1,632 |
| 75 | $1,551 | $1,435 |
| 70 | $1,294 | $1,254 |
| 65 | $1,132 | $1,116 |
Investing in an income annuity should be considered as part of an overall strategy that includes growth assets that can help offset inflation throughout your lifetime. Most financial advisors will tell you that the best age for starting an income annuity is between 70 and 75, which allows for the maximum payout.
You (or your beneficiaries) will generally get your money back because the insurance company is not basing the payments on your life expectancy. Instead, they know they need to pay it all back over a certain number of years, and they'll earn a profit while holding your funds.
How much does a $1 million dollar annuity pay per month?
If you purchase your $1,000,000 annuity between the ages of 60 – 70 and start taking payments immediately then you can expect to receive between $4,500 and $6,500 per month for the rest of your life or for the time period of your annuity payout.
Estimated Monthly Payments from a $250,000 Annuity
At age 65, monthly payments range from $1,387 for a single life with cash refund to $1,465 for a single life-only option.
It stipulates that if you withdraw money from an annuity before you turn 59 ½, you will incur a ten percent penalty on the taxable portion of the withdrawal. After age 59 ½, withdrawing your money as a lump sum rather than an income stream triggers income tax on your accumulated earnings.
As a retiree, when you get a lump sum pension payout, not only is this considered ordinary income, but the payout could also push your income into a higher tax bracket. And, depending on the size of the pension payout, it could trigger additional investment taxes on other sources of income.
While an annuity may offer more financial security over a longer period of time, you can invest a lump sum, which could offer you more money down the road. Take the time to weigh your options, and choose the one that's best for your financial situation.
