Whether you have to pay taxes on an annuity death benefit
will depend on what the death benefit is and the type of annuity originally
purchased.
Qualified Annuity
In a qualified annuity, the owner originally was able to
put the money away on a pre-tax basis, so taxes will be due as soon as money is
withdrawn at an ordinary income rate.
Non-Qualified Annuity
In the case of a non-qualified annuity (one purchased with
after-tax dollars), the beneficiary might not have to pay tax, depending on the
type of death benefit. Some death benefits to beneficiaries are refunds of
premium payment, rather than true death benefits.
In a refund case, the beneficiary gets back the remaining
amount that represents the premium paid but not recouped by the original annuitant
in the form of an income payment or withdrawal.
Hypothetically, if someone had a non-qualified annuity
purchased with a $100,000 premium and received $50,000 worth of payments before
passing away, his or her beneficiary would get the remaining $50,000. In this
case, the beneficiary would not have to pay taxes on the death benefit because
the death benefit would be considered a return of premium. This example is for
illustrative purposes only and does not reflect how product fees, expenses or
withdrawals would impact these figures.
In a true death benefit, however, the beneficiary might
actually accumulate interest above and beyond the premium amount. Any annuity
growth, which include amounts outside of premiums paid by the original owner,
will be taxed as ordinary income.
This also depends on how you receive the annuity death
benefit. If you take it out in cash, then the annuity gains will be considered
taxable as regular income. But if you’re inheriting a qualified annuity (one in
an IRA or 401(k)) from your spouse, then you would be permitted to roll that
qualified annuity into a qualified account tax-free. Non-spousal beneficiaries
can do this as well, but in that case, the annuity would need to be rolled into
an inherited IRA, which would be a special account set up in the decedent's
name to benefit you. In the case of a rollover, you’ll pay tax on any
withdrawals made, rather than the whole amount.
Trust as a Beneficiary
This topic will be the subject of our next blog on
annuities we will go into detail regarding the problem with naming a trust as
the beneficiary.
At John L Mottram CPA LLC Certified Public Accountants we have the insights you need to
establish the right time of annuity to minimize taxes. Contact John
L Mottram directly at jlm@mottramcpas.com or on 214-543-1855. Also go to our
website at www.mottramcpas.com to sign up for our regular tax updates.
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