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What is Annuity? What's its role in tax calculations.? |
What is Annuity? What's its role in tax calculations.? There are two meanings. The first is the broader meaning from Finance. It is a series of periodic payments, usually fixed in value and schedule. The second is the more common meaning. It is a an insurance contract that defines a series of periodic payments from an insurer. It is designed to guarantee that no matter how long you live, you cannot outlive your savings. With life insurance, the insurer is betting you will die old, with an annuity they are betting you will die young. There are a variety of contracts available. First, a deferred contract is a contract in which payments are deferred to a distant future date. In the United States, no tax is due on the contract earnings until the money is delivered either through a withdrawl or by periodic scheduled payments. The second is an immediate annuity. Those are contracts in which the first payment is due from the company is due within one calendar year. Of these payment schemes, there are a variety of categories. The first is the simplest, it is the payment certain annuity. The insurer will make a certain number of payments on fixed dates according to a contractually agreed amount. For example, for an initial payment of $50,000 received today, they will pay $505 per month for 120 payments beginning on March 1, 2006. The next common and simple one is life annuity. For a fixed amount of consideration, the insurer agrees to pay a contractual amount periodically (usually monthly) for the annuitant's entire life regardless of how long or short they live. For example, a male born July 1, 1940 and residing in West Virginia, would receive $334 per month for as long as that person lived beginning on March 1, 2006. If that person died on March 2nd, they would only be entitled to that one payment. On the other hand, if they died in 2046 they would have received payments for forty years. Moving away from the simple, there are a variety of other options. For example, there are joint annuities that pay for as long as any annuitant is alive. There are also refund annuities and life annuities with period certain. A refund annuity guarantees that regardless of how long the annuitant's live, they will at least break even. In the event all annuitant's died before recovering their principal, payments will continue to a beneficiary until the contract breaks even. A life annuity period certain, guarantees that if they annuitant's die prior to a certain amount of time, payments will continue to a beneficiary. And to complicate it a little more, there are fixed annuities and variable annuities. A fixed annuity guarantees a fixed payment, a variable annuity ties the payout to an index such as inflation or the stock market. As for tax calculations, I hate to say, "It depends," but for most people the answer is pretty simple. The IRS produces a life expectancy table, you are required to amortize your cost basis over your life expectancy with the difference being taxable income. For fixed period annuities, the payout period is equal to the fixed period. An example may help, using the example from above. I will provide the information Berkshire Hathaway profides to a purchaser. "Your investment of $50,000 will yield 4.55% based upon our mortality assumptions and the U.S. Treasury yield curve as of January 12, 2006. This investment will provide you with $334 every month for as long as you live, beginning on March 1, 2006. Under current IRS rules, if your annuity is purchased with non-qualified after-tax dollars, your annual after-tax cash payment, assuming a marginal tax rate of 40.0%, will be $3,442 every year for the first 19.1 years because the IRS will consider 64.7% of each payment to you a return of your principal. which is = 21,522.0%. Any payments you may receive after 19.1 years will be fully taxable, reducing your annual after-tax cash return to $2,405 thereafter. " Source(s): http://www.brkdirect.com/spia/ezquote.as... |
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