A.: Kenny, some investment assets increase with the death of the owner, but not all. Like US Savings Bonds, traditional IRAs, 401 (k), 403 (b), and other retirement plans, there is no mark-up for non-qualifying annuities. Annuities provide tax-deferred, non-tax-exempt income. These deferred earnings are considered “deceased person income” after the death of the original owner and are taxed as ordinary income when paid to the beneficiary.
With an ineligible deferred annuity, you take out a contract with an insurance company. Winnings are not taxed until you withdraw money.
So, suppose you buy a non-qualifying deferred annuity for $ 100,000 and increase it to $ 200,000. Unless the contract was purchased before August 14, 1982, the first dollars withdrawn are deemed to be earnings and are taxable to the owner of the contract.
Need $ 20,000 for repairs? All $ 20,000 withdrawn from the annuity will show up on your tax return as regular income. At this point you have an account of $ 180,000 of which $ 100,000 is base costs that will never be taxed and $ 80,000 is income, taxable to you when you withdraw it. As income in respect of a deceased person, the $ 80,000 is taxable as ordinary income for any beneficiary who receives it after your death.
If a contract is turned into an annuity – converted into a contractual payment stream – part of the payment will be a basic return and not taxed, but that deferred income will still be taxable as it is received.
Compare that to investing in a traditional taxable account worth $ 200,000 with a base of $ 100,000. Need $ 20,000? Tax is calculated differently and is based on the ratio of gain to cost base. To get $ 20,000 in cash, you sell enough stock to generate $ 20,000 in proceeds. In this case, of that $ 20,000, $ 10,000 is a capital gain ($ 100,000 / $ 200,000 = ½. Half of $ 20,000 is $ 10,000). Only the $ 10,000 gain is reported on your income tax return.
In addition to calculating the amount that appears on your Form 1040 in a different way, long-term capital gains (gains on assets held for more than 12 months) are taxed at different rates than regular income. Long-term capital gains rates are lower than ordinary income rates for all taxpayers regardless of their income level. Depending on your taxable income, a gain of $ 10,000 is taxed from 0 to 23.8% at the federal level. Ordinary income rates are currently 40.8% (37% plus 3.8% tax on net investment income).
After taking the $ 20,000, you then have an account of $ 180,000. $ 90,000 are base costs that will never be taxed and $ 90,000 are unrealized capital gains. These gains are taxable when you sell the stake.
If the farm was worth $ 180,000 on the date of your death, assuming you are the sole owner, the base cost of the entire farm is “increased” to $ 180,000. Your heirs could then sell the property and calculate their gain or loss based on $ 180,000, not $ 90,000. If they sold $ 180,000, they would pay no income or gains tax.
Ineligible deferred annuities can be useful tools, but they are subject to unique tax rules. Sometimes these rules can work to your advantage, but if you’re not careful, you can take advantage of avoiding income taxes in the present time to regret creating a bigger tax bill for you or someone. else in the future.
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Dan Moisand is a financial planner with Moisand Fitzgerald Tamayo serving clients nationwide, but with offices in Orlando, Melbourne and Tampa, Florida. His comments are for informational purposes only and do not substitute for personalized advice. Consult your advisor to find out what is best for you. Some questions are edited for brevity.