Most years, summer cannot begin until taxes are filed. This year is different, however, for most taxpayers. Due to the coronavirus pandemic, the IRS issued a postponement of the federal tax filing due date from April 15 until July 15, 2020 (for the 2019 tax year).1
Hopefully, most clients made good use of mandatory stay-at-home orders to complete their federal taxes, especially if they were due a refund. Those who owed additional taxes may have already submitted their payments despite the extended deadline of July 15. If your clients haven’t yet filed, however, they may want to consider additional investment opportunities.
Prior Year Contributions Deadline Extension
Unless clients file for an extension to October 15, most tax filers must complete many of their tax responsibilities by mid-July. Even though the deadline is quickly approaching, those who haven’t completed and submitted their 2019 taxes yet may be able to make those prior year investment contributions that are usually tied to the tax filing deadline. Some examples include IRAs, Health Savings Accounts (HSA) or Archer MSA contributions.
When the tax filing deadline was extended to July 15, so were the prior year’s contribution deadlines for many of these types of investment accounts.2
Review Annuity Investment Taxes
While we’re finally putting a close on the 2019 tax year, now is also a good time to review taxation of annuity investments and income for future tax years. In addition to cost of living adjustments for the 2019 tax year, there are a few tax considerations when it comes to annuities:
Non-qualified tax treatment. Amounts not received as an annuity are not yet taxed, so long as funds are not removed from the annuity. Generally, withdrawals are taxed to the extent of any gain in the contract as being withdrawn first (LIFO-last in, first out), then any additional distribution is tax free once the gain is exhausted because the initial principal and any subsequent contributions used to fund the account were already taxed. It’s important to emphasize to your clients, however, that annuities are tax-deferred, not tax-free.
Money received as an annuity. For amounts received as a payout option, or annuitization, a portion of each payment is generally considered to represent a return of after-tax premiums or other considerations paid being excludible from income and a taxable amount. The amount includible and excludible is determined using an exclusion ratio. Once the investment is exhausted, the entire amount of each payment becomes taxable and includible income.
Annuities held tax qualified. This may include any qualified account, individual or employer plan, which may hold an annuity. Distributions are treated according to the rules of the qualified account; so eligible qualified Roth IRA distributions, for example, are received tax-free, including both the return of premiums and gains.
Guaranteed Withdrawal Benefit riders. It’s important to note that these are usually taxed as withdrawals, meaning gains are distributed first as fully taxable ordinary income, second as untaxed return of principal, and thirdly as fully taxable ordinary income again (for any benefits paid after the actual annuity contract balance is reduced to zero).
While the benefits of net payment amounts on Guaranteed Withdrawal Benefits can be clear, the tax load may not be as desirable as spreading the tax burden over a lifetime with annuitization, and a fresh review of a client’s tax situation can help show how one option could be clearly more beneficial than another.
Understanding the tax implications on annuities can be complicated, and a tax professional is best suited to provide in-depth tax advice. Still, it’s important for advisors to stay informed about different opportunities they can leverage for their clients.
We’ve developed several resources to help you dig deeper, including insights into income planning, annuity strategies, rollovers, legacy planning and more on our Elevate Advanced Planning Resources page. Check it out and reach out to me with any questions. I’m here to help.
Written by: Marshall Heitzman, CFP®, ChFC, FLMI, CPCU, BFA™
Marshall is CUNA Mutual Group's Head of Advanced Planning and has more than 25 years experience in the insurance and financial services industry. He consults Financial Advisors on advanced retirement planning concepts for retirement and wealth management clients.
1IRS.gov, Filing and Payment Deadline Extended to July 15, 2020 - Updated Statement, April 14, 2020
2 IRS.gov, Taxpayer Relief for Certain Tax-Related Deadlines Due To Coronavirus Pandemic, April 16, 2020