Some annuities are based on a tax deferred method and therefore you can deduct your annuity premiums paid for a qualifying annuity. However, if you own a nonqualifying annuity then you cannot deduct your annuity premiums paid.
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Annuities are either qualified annuities, which means they qualify as tax deferred investments or they are nonqualified annuities, which means they do not qualify as tax deferred investments. The difference between the two is pre-tax dollars versus after tax dollars.
Most qualified annuities are funded through employee payroll deductions, so you can’t take a deduction on your taxes for those contributions. However, if you are self-employed or paying for a qualified annuity after taxes, then your annuity premiums may be deductible. Qualified annuities are tax deferred and so you do not have to pay taxes on that money until you begin to withdraw it at retirement age. Or, if you withdraw your money early you will have to pay taxes on it at that time.
Nonqualified annuity premiums cannot be deducted at all. Nonqualified annuities are paid with after-tax dollars so there is nothing to deduct from your taxes. However, that also means that you won’t owe any income taxes on that money when you begin to withdraw your funds either.
Pre-taxed and Deductible Annuity Premiums
Qualified annuities are only available through an employer, which means you typically pay for your annuity premiums through payroll deductions. Anytime you pay for retirement investment options through payroll, the money contributed is not subject to income tax.
By that same token, if for some reason you had a qualified annuity that was not funded through payroll, then you would be able to deduct your annuity premiums paid. This may happen with a qualified annuity through a self-employed person or a qualified annuity from an employee who does not have taxes withheld from his check.
Tax deferred qualified annuities are deductible either through payroll pre-tax dollars or through your income tax reporting. However, at the time you withdraw your funds, whether it is prematurely or through your planned monthly income earnings, you will have to pay income taxes on that money.
Non Deductible Annuity Premiums
Most annuities are not deductible, meaning they are not purchased through pre-tax payroll deductions. If you purchase a private annuity (not through an employee option), then you are buying a nonqualified annuity.
Nonqualified annuities do not qualify as a tax-deferred investment plan. Rather, they are bought with after tax dollars and therefore you cannot deduct your annuity premiums paid on your income taxes. However, unlike qualified annuities where you are taxed at the time of withdrawal, you will not have to pay income tax on your money when you take it out of your account.
Gains from Annuities are Not Deductible
There is little difference if you pay income tax on your qualified annuity at the time you withdraw your money or if you pay income tax on your money before you buy a nonqualified annuity. The actual difference is really a matter of timing since you will pay income tax on that money either way.
However, when you buy an annuity, you are buying an investment plan, which means your annuity is expected to grow. Usually annuities are invested conservatively so that there is a small rate of return but at least some type of growth can be almost guaranteed. That growth, the earnings on your annuity, is also taxable.
Whether you can deduct the annuity premiums paid or not depends on the type of annuity you buy; but the income from your earning must be paid at the time you withdraw the money or at the time you file your income taxes no matter what type of annuity you have.
Since annuities are conservative investments it is unlikely that your annuity will lose money. If it does, however, you may be able to deduct your losses. In order to deduct your annuity losses, the loss must be greater than 2% of your adjusted gross income (AGI). If you have losses from your annuity investment you may want to speak to a tax or financial advisor regarding your options.
Annuities are intended to be vehicles for retirement savings. In order to discourage people from withdrawing their money early, the government imposes a 10% early withdrawal penalty. You will have to either pay this penalty at the time you pull your funds or you will have to report it and pay for it when you prepare your income tax forms.
There is no way around paying for your annuities tax free. You can defer your taxes by buying a qualified annuity from your employer and making contributions through payroll taxes or by deducting your annuity premiums paid from your income taxes. However, you will pay income tax on that money when you withdraw it from your annuity account.
Even though your annuity won’t save you money on income tax, it can be a good contribution for your retirement savings. Enter your zip code now to get free annuity quotes from different life insurance companies now!