Understanding the Taxation of Annuity GLWB Withdrawals

Annuities are popular financial products that provide a steady income stream, often used as part of retirement planning. One feature that can be added to an annuity is the Guaranteed Lifetime Withdrawal Benefit rider. This rider ensures that the annuity holder receives a guaranteed income for life, regardless of market performance. However, understanding how these benefits are taxed is crucial for effective financial planning.

What is a GLWB?

A GLWB is a rider that can be added to some annuities. It allows the annuity holder to withdraw a certain percentage of their account each year, guaranteed* for life. This feature ensures that the annuity holder will not outlive their income, even if the annuity’s account balance is depleted. Learn more about the Ameritas Income 10 Index Annuity with a GLWB rider.

Taxation of GLWB payments

The taxation of GLWB payments depends on several factors, including the type of annuity (qualified or non-qualified) and the source of the funds used to purchase the annuity.

1. Qualified annuities (IRA, 401(k), or other tax-deferred accounts)

• Fully taxable as ordinary income: If the annuity was purchased with pre-tax dollars (such as in a traditional IRA or 401(k)), then 100% of the GLWB payments are taxed as ordinary income when withdrawn.
• Required minimum distributions: For qualified annuities, the annuity holder must begin taking RMDs starting at a certain age. RMDs are the minimum amounts that must be withdrawn each year from retirement accounts. The GLWB payments can be used to satisfy the RMD requirements, but it’s important to ensure that the total withdrawals meet or exceed the RMD amount to avoid penalties.

Hypothetical example:

John, age 70, owns a variable annuity with a GLWB inside his IRA. He starts taking $30,000 per year in withdrawals. Since the annuity was funded with pre-tax money, the entire $30,000 is subject to ordinary income tax.

2. Non-qualified annuities (funded with after-tax dollars)

• Taxable portion based on exclusion ratio: If the annuity was purchased with after-tax dollars, GLWB withdrawals follow the LIFO (Last-In, First-Out) rule. This means earnings are withdrawn first.

Hypothetical example:

Mary, 68, owns a non-qualified annuity she bought with $200,000, and it has grown to $300,000. She begins GLWB withdrawals of $20,000 per year. Under LIFO rules, the first $100,000 of withdrawals (the gain) is fully taxable, and after that, her withdrawals will be tax-free until she has recovered her full $200,000 basis.

Taxation of GLWB payments in practice

When an annuity holder begins taking GLWB payments, the insurance company will calculate the exclusion ratio and apply it to each payment. For qualified annuities, the entire payment is taxable. For non-qualified annuities, the exclusion ratio determines the taxable portion.

It’s important to note that once the total amount of the principal has been returned to the annuity holder, all subsequent payments are fully taxable as ordinary income. This is because the exclusion ratio only applies until the principal has been fully recovered.

Tax reporting

Annuity holders will receive a Form 1099-R from the insurance company each year, detailing the total amount of withdrawals and the taxable portion. This information must be reported on the annuity holder’s tax return. It’s essential to keep accurate records of all annuity transactions to ensure proper tax reporting and compliance.

Strategies for managing taxes on GLWB payments

There are several strategies that annuity holders can use to manage the tax impact of GLWB payments:

1. Timing of withdrawals: Consider the timing of withdrawals to manage taxable income. For example, delaying withdrawals until retirement when income is lower can reduce the overall tax burden.

2. Diversification: Use a mix of qualified and non-qualified annuities to diversify the tax treatment of withdrawals. This can provide more flexibility in managing taxable income.

3. Consult a financial professional: Working with a financial advisor or tax professional can help annuity holders develop a tax-efficient withdrawal strategy that aligns with their overall financial goals.

Consider your options

Understanding the taxation of Guaranteed Lifetime Withdrawal Benefits is essential for effective retirement planning. By knowing how these benefits are taxed and implementing strategies to manage the tax impact, you can make informed decisions that support your long-term financial security. Consult with a financial professional to customize a strategy just right for you.

*Guarantees are based on the claims-paying ability of the issuing company.

Ameritas® does not provide tax or legal advice. Please consult your tax advisor or attorney regarding your situation.