What taxes will I owe on my annuity?

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Q. I am 66 years old and I bought non-qualified fixed annuities with six-year terms. I don’t want to annuitize. If I withdraw all the funds in a lump sum in six years, will I need to pay any taxes other than capital gains?
— Retired

A. We wonder why you purchased annuities if you had no interest in getting regular payments from the contracts.

There are a few items to consider here.

One of the benefits of a non-qualified fixed annuity is that any income is tax-deferred until the annuity is annuitized or withdrawn, said Michael Maye, a certified financial planner and certified public accountant with MJM Financial in Gillette.

He said non-qualified annuities are subject to their own set of tax rules. When withdrawals are taken from non-qualified annuities purchased after Aug. 14, 1982, the earnings are considered to be distributed first, he said.

“More importantly, the earnings are taxed at ordinary income tax rates and not capital gains rates,” he said. “So in the situation the reader described, if he were to withdraw the entire balance in six years as a lump sum, all earnings would be taxed as ordinary income.”

Maye said depending on your tax situation, you may want to consider annuitizing instead because it would spread out the income over time. A portion of each payment would be considered a return of premium based on an exclusion ratio provided by the insurance company, he said.

Taking a lump sum in one tax year could have some unintended consequences, Maye said.

It could mean increased taxability of Social Security, higher Medicare Part B and Part D premiums, and if your total income is more than $100,000, you could lose the New Jersey pension exclusion, he said. Plus, you could be in a higher federal tax bracket overall.

We recommend you speak to a financial advisor before taking the money as a lump sum.

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This story was originally published on May 7, 2019.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.