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HOW INCOME IS TAXED IN A LONGEVITY ANNUITY

 

 

Non-qualified (non IRA dollars) is tax deferred growth until income starts. Income payments are excluded from tax at a certain "exclusion ration" which is given on the company quotes.  Exclusion ration, often expressed as a percentage, is the return of deposit back in equal income tax free payments.  The left over percentage, which is interest and mortality credits or longevity credits, is taxed when income is received as ordinary income rates.  The internal revenue service calculations for the nontaxable portion of each year's payment is found in IRS code section 72(b)(1) which is the total deposit divided by the expected return received.

 

As an example a 58-year-old purchases a longevity annuity. He deposits $100,000 into the longevity annuity today. He customizes his annuity to start to receive annual income payments at age 75.  His annual longevity annuity income payments are $21,463 at age 75.

 

In this example the exclusion ratio is 35.8%. The annual income payment he receives is $21,463; the portion that can be excluded from gross income is $7,683 (35.8% of $21,463). The $13,780 balance of each $21,463 annual payment is taxed at ordinary income tax rates.

 

For longevity annuities issued after December 31, 1986, the excludable amount is limited to the investment in the contract. Once that amount is recovered, all future annuity payments are fully subject to ordinary income tax.  In the above example that $7,683 tax-free excluded income payment would last a little more than 13 years.

 

Qualified funds (401(k) rollovers, IRA & QLAC) are tax-deferred growth until income starts same as nonqualified funds. Income is tax at ordinary income rates when received.  Income must start the April after you reach age 70 1/2.  However the new Qualified Longevity Annuity Contract (QLAC) rule allows you to skip RMD until age 85.  QLAC amount is the lesser of 25% of your IRA balance or $125,000, which is inflated annually to the next $10,000. So given a three percent annual inflation rate that IRS limit would increase and become over $135,000 in 2017 and over $145,000 in 2019.

 

Roth IRAs are the exception to the rule.  Roth IRAs are qualified funds but have the required minimum distribution (RMD) exclusion so income start dates can surpass the age 70 ½.

 

 

 

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