A caller asks whether annuities are taxable and will be considered part of the annuity owner's estate when he or she dies.
First, basics. The U.S. Securities and Exchange Commission defines an annuity as a contract between you and an insurance company. You give the company money, either in a lump sum or as periodic payments. It invests the money and at some point, usually after you retire, makes periodic payments to you.
Are annuities taxable? Yes, no and maybe. The tax rules vary, based on the type of annuity and how you take the money, according to a July 10, 2009, article in Kiplinger magazine. How the annuity is funded also affects whether it is taxable.
Whether the annuity is part of your estate can also be a bit more complicated than it sounds. But the short answer is that the annuity will probably not be part of your estate.
The question of whether an annuity is taxable begins with type of annuity. There are immediate annuities, deferred annuities, fixed-period annuities, tax-sheltered annuities, annuities for a single life—you get the picture. There are annuities with fixed payouts, variable payouts or index-rate payouts, in which the interest you receive is based on a market index such as NASDAQ.
The Internal Revenue Service has tax rules for each type of annuity. The rules are in IRS Publication 575, which can be found by searching the IRS's website http://www.irs.gov.
If you receive periodic payments from an annuity, but you paid in nothing because your employer fully funded it as a pension plan or because you have already drawn out your contributions, your payments are fully taxable as income.
If you fund an annuity yourself with pretax money, such as an IRA, all payments you receive will be fully taxable. If you fund it with after-tax dollars, part of every payment you receive will be a tax-free return of the dollars you invested, but interest or other income you earn on your investment will be taxable.
Tax-sheltered annuities are available to individuals employed in certain professions. A tax-sheltered annuity plan, such as a 403(b) plan, is a retirement plan that allows employees of public schools and certain tax-exempt organizations to invest pre-tax contributions. The workers draw the money out after retirement, when it will presumably be taxed at a lower rate.
An annuity will probably not be taxable to your estate, depending on how it is set up. If it is a single-life annuity, the payouts terminate at your death, so no further payouts will be added to your estate. Some annuity sellers offer death benefit options. If you die before collecting payments from your annuity, your survivors receive payments under the death benefit option, but the payments are not left to them in your will and are not part of your probate estate.
Columnist note: A reader pointed out that a recent column on legal requirements after death failed to mention you can donate your body to the State Anatomy Board for medical science. Information: 410-706-3313 or
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Donna Engle is a retired Westminster attorney. Reach her with questions or feedback at 410-840-2354 or firstname.lastname@example.org. Her column, which provides legal information but not legal advice, appears on the second and fourth Sunday each month in Life & Times.