Chelsey Tucker graduated with a Bachelor of History degree from Metropolitan State University in 2019. She now writes about insurance with her specialty being life insurance and has been quoted on Help Smart Phone and MEL Magazine.

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Dan Walker graduated with a BS in Administrative Management in 2005 and has been working in his family’s insurance agency, FCI Agency, for 15 years. He is licensed as an agent to write property and casualty insurance, including home, auto, umbrella, and dwelling fire insurance. He’s also been featured on sites like Reviews.com.

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Reviewed by Daniel Walker
Licensed Auto Insurance Agent

UPDATED: Mar 19, 2020

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What is an annuity return of capital?

An annuity return of capital is the money that you get back when you invest in an annuity that is not part of your profit. This article will explain this concept in detail.

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Think about it this way. Say, for example, you invest $100,000 in an annuity. Your investment grows and, when you are fully vested in your annuity, your total annuity has $175,000 available. When you get your investment paid back to you, the $100K is your capital; it is not your profit.

What do capital and profit mean in regard to my annuity?

Many people actually confuse return of capital with return on capital. The return on capital is the other half of the equation. The $75,000 that you receive is the growth of your investment and that is the return on your initial or your return on capital.

An annuity, in general, is an investment that is used to turn your income into profit. This may seem rather simple, but that is really all it is. You invest in an annuity and watch your money work for you over the years. A fixed annuity not only offers you a guaranteed investment, it also offers you the ability to choose an investment with a guaranteed minimum profit, which in this case is an interest rate.

The benefit to choosing a fixed annuity is that, as a guaranteed investment, you never have to worry about how the stock market is doing over time. You are guaranteed to receive a certain amount of return on capital, even if the stock market crashes and the US enters into another depression era.

Of course, you will have to ensure that you choose an insurance company that is fiscally strong because an annuity is not guaranteed by the government. In other words, your investment isn’t insured like it would be if you were putting your money in a savings account. The good news is that there are dozens of fiscally strong insurance companies in the US that would survive even in the worst of times.

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Why should I care about understanding an annuity return of capital?

What you might be thinking right now is why should you care about this at all? After all, the only thing that most people are interested in is the bottom line, or how much of a return they are going to get on their investment.

When it comes to paying your taxes, however, you are going to care quite a bit. You see, if your initial investment is made from after tax money, or money that you have already paid taxes on, then you don’t have to pay taxes on that once you start collecting on your annuity. If you don’t know the difference between your return of capital or return on capital, you could inadvertently pay more in taxes than necessary.

What’s more, you could find that you put the wrong information on your tax forms, causing the IRS to place you into another tax bracket because it increases your total income for the year by $175,000 rather than the $75,000 that is taxable.

This doesn’t mean that if you hire a tax professional to do your taxes that you can pass the responsibility of learning about your annuity on to someone else. If you want to invest responsibly and ensure that you get the most out of your investments, then you need to make a point of understanding your investments and how they affect you.

A tax professional isn’t making your initial investments for you, you are. Taking the time to understand the value of an annuity as well as the risks and downsides ensures that you make good choices about your investments.

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What are your tax obligations on your annuity return of capital?

The answer to this question depends a great deal on where the initial capital came from. In order to invest in an annuity, you have to use cash, or the equivalent of cash, which could be direct deposit, check, money order, etc. In other words, you can’t directly roll an IRA or a 401K into an annuity.

This doesn’t mean, however, that you can’t use monies from either of these investments to contribute to an annuity. If, however, you choose to take your return on capital from an IRA or 401K and put it directly into an annuity before paying taxes, or to avoid paying any immediate taxes, then the entirety of your investment is going to be taxed.

The good news is that the taxes don’t have to be paid until you collect on your annuity, which, for many people, will be many years down the road. This means that you can ensure that more of your money works for you over the years.

If, however, you choose to invest money that has already been taxed, then your return of capital isn’t taxable when you start collecting on your annuity, only your return on capital. Don’t let this confuse you, it is actually very simple.

If you start your investment with taxed money, when you start receiving your annuity, the government will assume that your annuity is 49.9% taxable for a certain amount of time. How long will depend on how much money you invest, what your profit margarine is and how you plan on receiving your payment.

Your annuity payments will be considered income, which means that you will be taxed based on the tax bracket that your total annuity, plus any other income you receive, places you in. This is why many people choose monthly annuity payments over the course of several years over a single benefit payment once their annuity matures.

If you surrender your annuity or withdraw more than 10% from your annuity account before you are 59 and 1/2 years old, the government will add a 10% penalty tax on your withdrawal. Just like with annuity payments, the government will assume a certain percentage of that withdrawal is a return of capital that is non taxable if you invested with after tax money.

Can you roll your return of capital into another annuity?

If your contract with your insurance company is up before you turn 59 and 1/2 years old, then you could face a 10% penalty tax from the IRS. To avoid this you will want to consider putting your money into another investment.

You will not have to reinvest the entirety of your investment; in fact, you can keep your return of capital and simply reinvest your return on capital. If you do this, however, keep in mind that the total of your new annuity will be taxable when it matures and you collect on it. Since you were going to pay taxes on the return on capital anyway, this doesn’t present anything extra for you other than a larger return on your investment in the future.

Whether you are interested in starting a new annuity or reinvesting the money from an old annuity, you want to ensure that you are getting the most for your investment. To do this, you need to start with a comparison tool.

You see, every insurance company offers different fees and interest rates for your investment. By shopping around, you can find the investment that offers you the most interest while paying the lowest fees. Or, you may find that it is worth it to pay higher fees to an insurance company because it offers a much higher interest rate. Regardless, if you don’t take the time to look around, you simply won’t be getting the best deal.

Try our free quote and comparison tool to get online annuity quotes today!