Rule
An owner who elects to receive annuity payments from a nonqualified annuity can exclude a pro rata portion of those payments from their taxable income. This nontaxable return of premiums is known as the exclusion ratio.
The exclusion ratio provides a tax incentive for owners to annuitize amounts of their deferred annuity contract instead of taking regular withdrawals. However, it can have unexpected tax consequences for beneficiaries when the annuity owner* dies.
Different tax obligations apply depending on the benefit option selected by the annuity owner and whether or not the original nonqualified premiums have been fully distributed.
The beneficiary uses the same exclusion ratio applied to the original contract.
Life with period certain or refund payments
After the owner dies, payments to the beneficiary are excluded from taxable income until the remaining basis in the contract is exhausted. Once this happens, payments are fully taxable to the beneficiary.
Losses
If the owner dies before recovering their entire basis, theowner can deduct the amount of the unrecovered basis remaining after the payments cease on the owner's final tax return. If the contract provides for a cash refund feature, the beneficiary may take the deduction instead of the owner.
This deduction may be treated as a net operating loss, a special type of tax deduction used to offset income in current or future years.
What else should I know
Step-up in basis
Because annuities receive special tax benefits during the owner’s life, no step-up in basis is available to the beneficiary when the owner dies.
Rollovers
Death benefits paid from nonqualified annuitized contracts can’t be exchanged into a new annuity contract. The IRS treats these payments like regular required minimum distribution (RMD) payments.
* This article assumes the annuity owner and annuitant are the same person. For questions on different scenarios, contact annuity advanced markets.
The subject matter in this communication is provided with the understanding that Principal® is not rendering legal, accounting, or tax advice. Your client should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.
Call your wholesaling team with questions about annuities or contact Scott Van Wyngarden in annuity advanced markets at 515.247.6785 or VanWyngarden.Scott@principal.com.
496541-052018
As a seasoned financial expert with a wealth of knowledge in tax planning and annuities, I can confidently delve into the intricacies of the Web Content Viewer Rule and its implications for nonqualified annuity owners and beneficiaries. My extensive experience in the field has equipped me with a deep understanding of the tax nuances associated with annuity payments and the exclusion ratio.
The Web Content Viewer Rule is a crucial aspect for owners opting for annuity payments from a nonqualified annuity. The exclusion ratio plays a pivotal role in allowing owners to exclude a pro rata portion of annuity payments from their taxable income. This exclusion ratio serves as a tax incentive, encouraging owners to annuitize portions of their deferred annuity contracts rather than opting for regular withdrawals.
However, the complexity arises when considering the tax consequences for beneficiaries after the demise of the annuity owner. Various benefit options and the distribution status of the original nonqualified premiums determine the tax obligations for beneficiaries.
In the case of a period certain (no life) option, the beneficiary applies the same exclusion ratio as the original contract. For life with a period certain or refund payments, payments to the beneficiary remain tax-exempt until the remaining basis in the contract is depleted. Subsequently, the payments become fully taxable to the beneficiary.
In instances where the owner dies before recovering the entire basis, the owner or beneficiary may be eligible for a deduction on the unrecovered basis, which could be treated as a net operating loss. This deduction serves as a special tax benefit to offset income in current or future years.
It is crucial to note that due to the special tax benefits accorded to annuities during the owner's life, there is no step-up in basis available to the beneficiary upon the owner's death. Additionally, death benefits from nonqualified annuitized contracts cannot be rolled over into a new annuity contract; instead, the IRS treats these payments as regular required minimum distribution (RMD) payments.
In conclusion, the Web Content Viewer Rule brings to light the intricate tax considerations associated with nonqualified annuity payments and emphasizes the importance of strategic planning for both owners and beneficiaries. As this information is complex and can have significant financial implications, individuals are advised to seek advice from qualified professionals to ensure proper understanding and compliance with legal, accounting, and tax obligations.
