Wednesday, August 10, 2016

Understanding the Non-Qualified Aggregation Rule

The non-qualified annuity aggregation rule is a lesson in tax awareness. While I’m not a tax professional, I want to shed some light on IRS Rule Sec. 72(e)(12) as a reminder of how taxation of annuity withdrawals may be treated in this specific scenario.

The current rule states that multiple non-qualified deferred annuity contracts issued within the same calendar year, to the same owner, by the same (or related) insurance company, are treated as one policy for determining the tax consequences of any distribution from any one or more of those policies. Therefore, if a client makes a withdrawal from one of those annuities, the taxable amount will be derived from the earnings of all polices issued to them that calendar year, at that carrier. The policy issue date is the date historically used by IRS to determine the qualification date of the policy, so keeping an eye out for this specific date is important.

Let’s illustrate this with an example. In 2014, John bought three deferred annuity contracts with one insurance carrier for $20,000 each. Each annuity contract has a cost basis of $20,000. Now in 2016, each contract has individually had $1,000 worth of growth. John decides to take a $3,000 distribution from one of the contracts. You may think that the $1,000 of growth in that contract is taxable and the rest would not be because it is part of the cost basis. However, in this situation, the IRS would look at the growth of all three policies purchased in 2014 from that carrier. Therefore the full $3,000 would be taxable. Even though all of the funds would come out of just one policy, the taxes would be based on the aggregated growth of all three. The cost basis would then be adjusted to avoid double taxation.

Because these rules are based on the contract owner, having different beneficiaries will not circumvent the rule. When appropriate, spouses can each have their own contract and not be impacted by this rule as well as ensuring the contracts are issued in different calendar years. Immediate fixed annuities or annuities purchased with qualified funds are also exempt from this rule. The rule applies only to non-qualified deferred annuity contracts, as previously mentioned.

Ultimately, this is not a terribly common scenario, yet is still very important to be aware of. If this situation comes up while you are assisting your client in achieving retirement or other financial goals, keep the tax consequences in mind. It is important to have a trusted tax advisor your client can consult in these situations to ensure that all aspects of the client’s situation and tax consequences are considered. The tax advisor could be a good referral source for you as well.

If you have any questions on this topic, call your marketer at Ann Arbor Annuity Exchange for more supporting material on the aggregation rule for non-qualified annuities. As always, for tax-related matters, seek guidance from a qualified tax professional.

Ann Arbor Annuity Exchange
Ph: 800.321.3924

This article is designed to provide general information on the subjects covered. It is not, however, intended to provide specific legal or tax advice and cannot be used to avoid tax penalties or to promote, market, or recommend any tax plan or arrangement. Please note that Ann Arbor Annuity Exchange and its representatives do not give legal or tax advice.  Encourage your clients to consult their tax advisor or attorney.

Designed for Financial Professionals.