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How are annuities taxed?

Taxes on financial products often vary and can be confusing when you’re first starting out. It can also be challenging to know how certain products are taxed in comparison to others. Take a closer look at what you should consider regarding the taxation of annuities before making a purchase.

The taxation of an annuity varies based on the type of annuity, but the one tax benefit they all share is that money invested in the contract grows tax free while it remains inside the contract. With the exception of Roth annuities, income from an annuity (i.e., money withdrawn from the contract) is generally subject to the same tax rates as wages. However, special rules do exist for measuring the portion of a withdrawal that is treated as “income,” but the income itself (no matter how it’s measured) is simply a type of ordinary income. 

What should I consider about taxes before buying an annuity?

F&G issues three types of annuities: “nonqualified,” traditional IRAs and Roth IRAs. Unlike nonqualified and traditional IRAs, the owner of a Roth IRA is not taxed on money withdrawn from the contract, assuming certain requirements are met.

Traditional IRAs can be bought with pre-tax funds. Nonqualified and Roth IRAs cannot. There are also strict limits on investing pre-tax funds in a traditional IRA.

 In general, if you are able to invest pre-tax funds in a traditional IRA, you could have some additional benefits. Investing after-tax funds in a Roth IRA can also be beneficial, since money withdrawn later is not taxable. However, there are strict limits on investing after-tax funds in a Roth IRA, so be sure to check with your financial and insurance professional on those limits.

Money taken from a Roth IRA is tax free. What you choose to spend your withdrawn Roth money on is a decision separate from the Roth contract.

If you want to buy an annuity with the Roth funds, you can. However, if you want the benefits of an annuity, then you may want to leave the money in your Roth IRA. Taking it out of a Roth IRA and reinvesting it in an annuity may not make sense, given the new surrender charges, fees, commissions, etc. that would be involved in a new annuity purchase.

Ultimately, the tax treatments of an annuity will vary based on individual circumstances that should be reviewed with a tax advisor or financial professional. Talk with your financial professional to see if an annuity fits your financial needs.

Have some questions about annuities? Find the answers you're looking for in "Get Answers to Common Annuity Questions".

Information provided regarding tax or estate planning should not be considered tax or legal advice. Consult your own tax professional or attorney regarding your unique situation.