20 Sep How do I figure out the taxes owed on my annuity payouts?

Q. I will be using the General Rule to determine the federal nontaxable portion of my annuity distributions. The annuity has a refund feature with a duration of 15 years. IRS Publication 939 (Table VII) is what I’m following in my tax calculations. It reduces by cost basis in the contract by the calculated dollar value of the refund feature. But I don’t see the refund feature discussed in any of New Jersey’s tax guides.
— Working the numbers

A. Annuities can be complicated products.

And as you see, that’s no different for the tax treatment.

Let’s start by recommending you meet with a tax preparer who can review the specifics of your situation.

But here are some things to consider.

An annuity is a series of payments you will receive; usually for life, said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown.

“An annuity can be pension payments from a previous employer or it could be an annuity purchased from an insurance company,” he said. “You purchased the annuity with a lump sum or you made periodic payments over time.”

Distributions from your pension or annuity plan may include amounts treated as a recovery of your cost, which is your investment in the contract, he said.

“If any part of a distribution is treated as a recovery of your cost, that part is tax free,” Kiely said. “Therefore, the first step in figuring how much of a distribution is taxable is to determine the cost of your pension or annuity.”

He said your cost is how much you invested using after-tax dollars, he said.

The IRS has the General Rule and the Simplified Rule for determining how much of your payment is taxable, Kiely said.

The Simplified Rule is for much older plans, and the General Rule is for more recent plans, he said.

The General Rule includes a calculation based on your expected life expectancy, he said.

New Jersey also has annuity rules, he said.

“If you will recoup your entire cost basis within the first three years, then all of the payments received are all cost basis — and tax-free — until you have recovered your cost basis, and then the payments are all taxable,” he said, noting that you should use the General Rule for both your federal and your New Jersey tax return.

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This story was originally published on Sept. 20, 2023.

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.