Often touted as a tax-advantaged retirement income resource, the annuity is a complex insurance product. While it offers distinct tax benefits, it’s important to understand how it works from a tax perspective. The following are six important facts you should know:
- Most contributions are not tax-free; the money you initially contribute is not deductible from your tax return.
- The exception to this is if you hold an annuity within a traditional tax-deferred account, such as an IRA or 401(k) plan. This is known as a qualified annuity.
- Whether you purchase an annuity alone or within a qualified retirement plan, your earnings will grow tax-deferred until distributed.
- Annuities are meant for retirement or other long-term needs so they come with a surrender charge period during which you may not be able to withdraw funds without incurring a surrender charge. In addition, withdrawals taken prior to age 59 ½ may be subject to an additional 10 percent federal tax.
- The IRS does not impose a limit on contributions to an annuity like it does for IRAs and 401(k)s.
- You generally have to start taking withdrawals from your IRAs or other retirement plan accounts, including qualified annuities, when you reach age 70 ½.
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