There’s never a bad time to review tax rules when it comes to annuities. These include:
- How the aggregation rule can affect your clients’ taxes on withdrawals; and
- How a Roth Conversion tax basis is calculated on a traditional IRA that is in an annuity when there are additional benefits such as a living or death benefit for tax calculation.
In 1988 Congress added Section 72(e)(11) to the Internal Revenue Code. This section refers to the aggregation rule. When there are multiple deferred annuities issued by the same insurance company to the same policyholder during any calendar year (sometimes called “serial contracts”), these contracts will be treated as one annuity for tax purposes. This change was implemented to stop the marketing of multiple deferred annuities to avoid the income-out-first rules of Section 72(e).
Why is it important that any withdrawals coming out of one contract will be considered a withdrawal out of all contracts? This rule could cause a sizeable tax event. Be conscious of multiple contracts with the same insurance company to be sure they were not all issued in the same calendar year and, if they were, plan accordingly.
Roth conversions of traditional IRAs that are in annuities that have added benefits such as living or death benefits are treated differently than annuities without them when establishing the tax basis. The amount that will be taxed is the accumulation value of the annuity plus the present value of any future benefits. Obviously, this rule means that a client who converts an annuity with these types of benefits may have a larger than anticipated tax bill. This rule will apply to income benefit riders, living and death benefits.
If you have any questions, please note them in the comments or contact me at dhayes@assetmarketingsystems.com.