A Tax Deferred Is A Tax Saved
A tax deferred is a tax saved. Tax deferral expected return of $361,245. That gives him an
works because the taxpayer earns a return on the exclusion ratio of 14% ($50,000/$361,245).
amount that he or she otherwise would have sent Arnold will exclude about $2,749 (19,633 x 14%)
to Uncle Sam in taxes. That, of course, leads us from each year’s payment until he recovers all
to a brief discussion of the tax treatment of an- his original investment. Thereafter, 100% of the
nuity contracts. For purposes of this article, we payment is taxable.
are restricting our comments to some of the rules Withdrawals from annuity contracts issued af-
governing regular, non-qualified annuities. An- ter August 13, 1982 that are not made in the
nuity contracts that are part of IRAs, 403(b) plans, form of an annuity are considered to be ordinary
401(k) plans and other qualified retirement plans income first, to the extent of any earnings inside
are covered by different rules. the contract, and then a return of capital. Con-
The taxation of distribu- gress has imposed a 10% penalty tax (in addi-
tions from annuity contracts tion to any contractual penalties) for withdrawals
depends on two factors: made prior to turning 591/2. The tax is based on
first, whether the with- the amount of the withdrawal that is included in
drawals were made in the taxable income. Like most tax rules, there are
form of an annuity and, sec- some exceptions to the 10% penalty.
ond, whether they were The penalty does not apply to withdrawals
made before or after the included in taxable income: 1) made on account
year you turned 59 1 / 2 . If of death or disability; 2) attributable to premi-
payments from the contract ums paid before Aug 14, 1982; 3) annuity pay-
are received in the form of ments that begin within 1 year of the date the
a fixed annuity payment, Arthur contract was purchased; and 4) that are part of a
the taxpayer may exclude Rottenstein, CSA series of substantially equal payments over the
a portion of each payment life of the taxpayer or the taxpayer and a desig-
that is considered to represent his or her original nated beneficiary. There are other exceptions that
investment. The amount excluded is computed relate to annuities inside retirement plans and as
by first calculating the “exclusion ratio.” The ex- used in structured settlements of litigation.
clusion ratio equals the original investment di- Of course, this brief article is no substitute for
vided by the expected return. The expected re- a careful consideration of all of the advantages
turn is calculated by multiplying the annual pay- and disadvantages of this matter in light of your
ment by IRS approved life expectancy tables (as- unique personal circumstances. Before imple-
suming a life annuity) or the period certain of menting any significant tax or financial planning
the annuity. strategy, contact your financial planner, attor-
Here’s an example: Arnold invests $50,000 ney or tax advisor as appropriate.
in a deferred annuity contract. Several years lat- Arthur Rottenstein, CSA is a Certified Senior Advisor
and a Registered Securities Principal with Raymond James
er when the contract is worth $225,000, Arnold Financial Services, Inc. in Boca Raton. He has been man-
(then age 67) elects a single life annuity. The aging the financial affairs of a number of select families in
company promises to pay him $19,633 per year. South Florida since 1982.
Using the IRS single-life unisex tables, Arnold’s Please feel free to call for an appointment at (561) 391-
6961 or email him at firstname.lastname@example.org
life expectancy is 18.4 years. That gives him an or visit his website at bocaratonfinancialplanner.com.