Many people know that they must start taking distributions from Individual Retirement Accounts (IRAs) at age 73. This IRS requirement is designed to end a part of the tax-deferred growth and begin collecting taxes on those funds.
Non-qualified annuities also offer tax-deferred investment growth, similar to IRAs. However, unlike IRAs, you are not required to begin taking taxable distributions from these accounts at age 73.
Non-qualified annuities mature at an age or date specified in the contract, most often at age 85. It is at this age or date that a policyholder must decide how to begin taking income from the account—and start paying tax on the deferred gains. Options include immediate annuitization, a period-certain payout, delaying payments, or distributing the annuity in full, paying all deferred taxes in the year of distribution.
Popular Payout Options
Immediate single life annuities have advantages and disadvantages, so it’s important to evaluate them carefully. One disadvantage is that as life expectancy shortens after age 85, the probability of getting the full value of the annuity returned to you during your lifetime diminishes. In this case, the insurance company typically benefits from this outcome.
To increase the return on their money over their lifetimes, many people consider annuitizing for a specific period. In this choice, the value of the contract at a specified interest rate is used to calculate a fixed payment over a fixed period of years.
Period-certain annuities may be an overlooked option for many policyholders. The hidden treasure in older annuity contracts is that the interest rate may be much higher than today’s interest rates. In addition, contract owners can name a beneficiary of the fixed income stream should they die before the end of the fixed period.
In some cases, an income stream is preferable to a lump sum. For example, a couple in a second marriage may want to provide for their current spouse but not want these monies to continue to the spouse’s heirs. The ability to name primary and contingent beneficiaries to the income stream allows the annuity owner the ability to direct these after-life income streams during their lifetime.
Indecision Can Be Costly
Upon the maturity of the annuity contract, you may be able to delay making a final decision on payout. Keep in mind that delaying the payment may force full payment of the annuity if you outlive the term of the continued income delay of the contract. For instance, if you delay payment for 10 years at age 85 and live to age 95, you may then be forced to take the total annuity value in a lump sum, incurring potentially significant tax consequences.
The maturity of the annuity may be a gift to annuity owners, helping them further contemplate their exit strategy for this tax-deferred investment.
Getting Ready to Make a Decision
To summarize, if you own an annuity, you should know the following:
- What is the maturity date of the annuity?
- What are the gains inside the annuity (the gain is the difference between what was paid for the annuity, including capital additions, and what it is worth today)?
- What is the strategy for paying taxes on the gain when a policy is surrendered or annuitized?
- Does it make sense for the current owner to pay the tax, or does it make sense for the heirs to pay their portion of the embedded gains upon inheritance?
- What is the current interest rate the fixed annuity is paying, and how does this compare to current interest rates?
Having answers to these questions should help you make better decisions to maximize the value of your annuity.
This article was originally published on December, 30 2020, and was updated for accuracy and relevance on the date above.
