Annuity taxes before 59.5

Jun 2, 2019

  1. J2727
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    J2727 Super Genius

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    This is quite confusing to me and would like to finally understand.

    If someone puts money into an annuity (MYGA or FIA), what's the situation with taxes?
    Everywhere I read it mentions the 10% penalty in addition to the income taxes owed.

    My question is on the 10% penalty.
    Forget about the surrender charge, just taxes.

    Example
    A 45 year old puts money into a 5 year MYGA or FIA.
    Gains are tax deferred for the 5 years.
    At the end of the 5 years he gets the money back.
    He owes income taxes on the gains.

    1) What about the 10% penalty? Is it owed or not?
    2) If there is a 10% penalty, can he just pull out the principal, tax free?

    Are all annuities subject to a 10% penalty for withdrawal of gains before 59.5?
    What about withdrawal of principal?
     
    J2727, Jun 2, 2019
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  2. Tahoe Ray
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    Tahoe Ray Guru

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    Your example....there is a penalty (on the gain).

    All annuities except SPIAs have the penalty on w/d (that also depends on the SPIA) which uses an exclusion ratio (returns part premium/part interest) over a certain time period (such as income for 20 years or for life)

    Annuities are LIFO (last in/first out) meaning that you can't just "pull the principal" since gains must come out first (as opposed to life insurance which is FIFO).

    While I won't debate why a 45yo should probably not own a MYGA (very rare circumstances IMO where that makes sense), what he/she could do is do a tax-free 1035 into a new MYGA (or indexed, variable etc.).

    There are exceptions to the penalty. Probably the most widely used is the SEPP (separate equal periodic payments) also known as a 72q (for non qual annuities). You can just google that term and there should be an explanation. It would be tough for a 45yo to do a SEPP because they are 15 years from age 60 and the income would be minimal.

    Hope that helps.
     
  3. J2727
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    J2727 Super Genius

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    That's what I figured.

    Regarding why a 45 year old would put money into a MYGA or FIA... maybe it's their bond equivalent or they want additional asset protection in a state which has creditor protection for annuities.
     
    J2727, Jun 2, 2019
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  4. Tahoe Ray
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    Tahoe Ray Guru

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    I didn't see the FIA alternative you posted originally (my apologies) and that's an excellent use for one (bond alternative). However, they are still normally better for older folks, because of this exact discussion (penalties).
     
  5. J2727
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    J2727 Super Genius

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    See my newer post about asset protection. Please give me your thoughts in that thread.
     
    J2727, Jun 2, 2019
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  6. Allen Trent
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    Allen Trent Guru

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    If they don't need the money at the time of the annuity interest rate maturity end date, they can re-up with the same carrier or 1035 to a new annuity carrier & continue to defer the recognition of the taxable gains. if they can continue to do this until after 59 1/2, they can avoid the 10% IRS penalty on the deferred interest gains.

    I believe the 10% penalty is also due even if you never deferred any interest. IE. 45 year old client deposits 100k in 3% annuity & immediately starts receiving $250 per month by taking out the interest. even though they never benefited from any tax deferral, they would still be subject to ordinary income taxes on the interest pulled out & a 10% early distribution penalty on the taxable interest reported on the 1099
     
  7. pfg1
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    pfg1 Guru

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    I was talking to someone I know a couple weeks ago. He's been doing this, has a carrier that has very good short term rates. I asked him how he was going to address the 10%... he said "its not IRA/Retirement money - no penalty". He's been in the business 20+yrs.

    IDK if its bad info being passed along by the IMO's or just not enough info being given. Many years ago when I first started, I had an IMO "annuity specialist" give me this same info. I pushed back and he basically told me that I was wrong. I didn't think I was and so I dug into it to confirm. I didn't do any business with them but I wonder how many did and had that nice little surprise down the road.
     
    pfg1, Jun 4, 2019
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  8. J2727
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    J2727 Super Genius

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    That's what confused me in the first place.

    If it wasn't IRA money and just money in a checking account, does the 10% penalty still apply?
    Everyone says yes, but I've seen people say what you just said, and so that's why I wasn't certain.
     
    J2727, Jun 4, 2019
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  9. Tahoe Ray
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    Money in a checking account? I'm not sure I follow that.

    It doesn't matter what the money is actually invested in, if it's in a non-qual annuity (which relates to how it is TAXED), then the penalty applies (from the discussion above).
     
  10. scagnt83
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    scagnt83 Worldwide Expert of Everything

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    The Technical Term is "Non-Qualified". Any IRA/401k/403b/Pension money is "Qualified". That is an IRS Term.

    And YES! There is a 10% Age Based Penalty on Withdrawals or Loans from Non-Qualified Annuities when the Owner is under age 59 & 1/2. Anyone who says otherwise has not taken the time to read an illustration fully.

    The reason for this, is because a Non-Qualified Annuity is Tax-Deferred. That is a benefit the IRS gives annuity owners for saving for retirement... but the trade off is you must wait until retirement.

    If an IMO ever tells you otherwise, have them send you a Non-Qualified Illustration. Read it. And then show them the line that explains the age based IRS tax penalty for Non-Qualified Annuities.
     
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