Deferred Annuity Payments Receive Tax Break from Small Business Jobs Act

Owners of non-qualified deferred annuities will benefit from a provision included in the recently passed Small Business Jobs Act of 2010.

Annuity owners who wish to annuitize only a portion of a deferred annuity are now able to do so, and the pro-rata rule will apply to partial annuity payments received after December 31, 2010.  The portion of the annuity that is not annuitized can continue to grow on a tax-deferred basis.

The application of the pro-rata rule to annuity income will result in an increase in the amount of net income received by annuity owners.

Previously, the income first rule applied to annuity payments so any annuity income would be fully taxable as ordinary income until all of the gain (the value of the annuity less the amount of after tax money that served as the premium) in the contract was received.

Under the pro-rata rule, only the portion of the annuity income that is considered a gain is taxable.  For example, assume that Joe invested $40,000 in a deferred annuity that has a current value of $50,000.  Also assume that Joe wants to annuitize $25,000.  Eighty percent of the monthly payments Joe received on this $25,000 will be tax free because the initial amount consisted of eighty percent invested premiums (the $40,000) and twenty percent earnings ($50,000 - $40,000 / $50,000).

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