Income Taxation of Annuities
Income Taxation of Premiums
Generally, premiums (either a single payment or monthly installments paid over the course of many years) that you pay as a Intel employee into an annuity are nondeductible. In other words, by placing funds within an annuity, you will not receive any current income tax savings. However, the earnings on the funds within the annuity will be tax deferred.
Caution: Generally, annuity contracts have limitations, exclusions, fees, and charges which can include mortality and expense charges, account fees, investment management fees, administrative fees, charges for optional benefits, holding periods, termination provisions, and terms for keeping the annuity in force. Most annuities have surrender charges that are assessed if the contract owner surrenders the annuity. Withdrawals of annuity earnings are taxed as ordinary income and may be subject to surrender charges plus a 10% federal income tax penalty if made prior to age 59½. Withdrawals reduce annuity contract benefits and values. Any guarantees are contingent on the claims-paying ability and financial strength of the issuing company. [Annuities are not guaranteed by the FDIC or any other government agency; they are not deposits of, nor are they guaranteed or endorsed by, any bank or savings association.] For variable annuities, the investment return and principal value of an investment option are not guaranteed. Variable annuity subaccounts fluctuate with changes in market conditions, thus the principal may be worth more or less than the original amount invested when the annuity is surrendered.
Income Taxation of Earnings on Funds Within The Annuity (Cash Value Buildup)
Generally, the earnings within an annuity accumulate income-tax deferred, and the annuity owner will not be subject to income tax on such earnings until they are withdrawn. As a Intel employee, you may want to keep this in mind when conducting financial planning and considering withdrawals.
Caution: Early withdrawals from an annuity (prior to age 59½) will not only be subject to tax but may also trigger a federal 10 percent penalty.
Income Taxation of Distributions from an Annuity
Distributions (partial surrenders, full surrenders, or annuitization payments) that are categorized as earnings are treated as ordinary income for tax purposes. For Intel employees, the income tax treatment of distributions from an annuity contract may vary based on the type of distribution method selected, and date the annuity contract was entered into.
Income Taxation of Partial Surrenders
If you are a Intel employee and entered into an annuity contract after August 13, 1982, a partial surrender of the annuity is taxed under the interest-first rule. The interest-first rule treats the partial surrender as coming from the earnings portion of the annuity first (until all the earnings have been withdrawn), not the principal. As a result, the partial surrender that is from earnings is included in the annuity holder's gross income and is fully taxable.
If you entered into an annuity contract prior to August 14, 1982, a partial surrender of the annuity is generally taxed under the cost-recovery rule. The cost-recovery rule treats the partial surrender as coming from the investment in the contract first (until all the investment in the contract has been exhausted). The remainder of the partial surrender, if any, is treated as coming from the earnings on the contract and is treated as ordinary income.
Income Taxation of Complete Surrenders
If you are a Intel employee and annuity holder, you may want to consider how if a holder completely surrenders an annuity, they become subject to income tax on the untaxed earnings (the difference between the cash surrender value of the contract and the net investment in the contract).
Example(s): Mr. Smith owns an annuity that has a cash surrender value of $80,000 and has paid premiums equaling $30,000 into the annuity. When Mr. Smith completely surrenders the annuity, he will be subject to income tax on $50,000 ($80,000 - $30,000).
Calculating a Loss on an Annuity Contract
An annuity holder may suffer a loss if he or she sells or surrenders a variable annuity for less than its cost basis. This may occur if the market experiences a downturn and the value of the investment decreases.
Example(s): Mr. Smith owns an annuity that has a cash surrender value of $80,000 and has paid premiums equaling $100,000 into the annuity. Mr. Smith completely surrenders the annuity, suffering a loss of $20,000.
Tip: A loss on a variable annuity is classified as an ordinary loss under Rev. Rul. 61-201, 1961-2 C.B. 46, not an investment loss reported on Schedule D. How to take the loss is an unsettled area of tax law. One approach is to take the loss as a miscellaneous itemized deduction subject to the 2 percent floor on Schedule A. Another approach is to take the loss on Form 1040, other Gains/Losses, deducting the full loss. Consult a tax professional. Any surrender charges incurred are not considered part of the loss.
Tip: For a life only annuity with a starting annuitization date after July 1, 1986, a deduction may be taken for the unrecovered investment in the contract if the total of all payments received does not equal or exceed the investment in the contract.
Caution: Variable annuities are long-term investments suitable for retirement funding and are subject to market fluctuations and investment risk, including the possibility of loss of principal. Variable annuities are sold by prospectus, which contains information about the variable annuity, including a description of applicable fees and charges. These include, but are not limited to, mortality and expense risk charges, administrative fees, and charges for optional benefits and riders. The prospectus can be obtained from the insurance company offering the variable annuity or from your financial professional. Read it carefully before you invest.
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Income Taxation of Annuity Payments
As a Intel employee and potential annuity holder, it is imperative to understand the income taxation of annuity payments. The tax code treats payments received as an annuity as being divided into two parts: a nontaxable portion that represents the return of the premiums paid into the annuity and a taxable portion that represents the earnings on the annuity. As a result, only a portion (i.e., the premiums paid into the annuity) is excluded from the annuity owner's gross income. The portion of each annuity payment that is excludable is determined by multiplying the number of payments received each year by an exclusion ratio. The fixed annuity exclusion ratio equals:
The annuity holder's investment in the contract (at the annuitization starting date) divided by the expected return.
Example(s): Mr. Smith has a fixed annuity contract that pays him $200 a month for 20 years. His expected return is $200/month x 20 years x 12 months/year = $48,000. Mr. Smith has an investment in the contract of $24,000, and his exclusion ratio is $24,000/$48,000 = 50 percent. As a result, 50 percent of each $200 payment ($100) would be excludable from Mr. Smith's gross income. The rest of his payment ($100) is treated as ordinary income.
Caution: The rules are different for variable annuities. Since variable annuity payments fluctuate in value, it is impossible to estimate the expected return at the starting date of the annuity. Typically, the excludable portion is determined by dividing the investment in the contract by the number of years over which it is anticipated the annuity will be paid. This calculation may vary depending on the annuitization option chosen.
Tip: All deferred annuity contracts issued by the same insurance company to the same policyholder during any calendar year are treated as one annuity contract.
Section 1035 Exchanges and Partial Exchanges
In general, under IRC Section 1035, as a Intel employee and annuity holder, you can exchange one annuity for another without the immediate recognition of any gain or loss. The exchange can be a complete exchange of one policy for another, or a partial exchange involving the direct transfer of a portion of funds invested in an existing annuity contract to a new annuity contract. However, to obtain this favorable tax treatment, the exchange must satisfy the requirements for a Section 1035 exchange.
Caution: The rules governing 1035 exchanges are complex and you may incur surrender charges from your 'old' annuity. In addition, you may be subject to new sales and surrender charges for the new policy.
Income Taxation When Gifting an Annuity
There are two ways for an annuity owner to make a gift of an annuity to another individual:
- The annuity holder can surrender the annuity and give the cash to the individual. However, this method of gifting an annuity will result in the annuity owner being subject to income tax on the untaxed earnings (the cash surrender value of the contract minus the net investment in the contract). In addition, surrendering the annuity and giving away the cash deprives the individual receiving the gift of the ability to continue accumulating tax-deferred interest within the annuity. For Intel employees who are considering gifting an annuity, you may want to explore other options than surrender given the income tax and inability to accrue tax-deferred interest.
- The annuity owner can transfer ownership of the annuity contract to the individual. After the transfer, the annuity contract will continue to exist, with the individual receiving the annuity as the new owner. However, this method of gifting an annuity also generally has immediate tax implications for the transferor. If the transfer involves an annuity contract that was issued after April 22, 1987, the transferor of the annuity is treated as having received income equal to the difference between the cash surrender value of the contract at the time of the gift and his or her net investment in the contract. For those employed at Intel, you `may want to take this information into account when choosing between transferring means for an annuity.
Example(s): Mr. Smith wishes to make a gift of an annuity to his daughter Alexandra. Mr. Smith purchased the annuity contract after April 22, 1987. He has paid $12,000 in premiums into the annuity, and the annuity has a cash surrender value of $20,000. When he gifts the annuity to his daughter, Mr. Smith will recognize taxable income of $8,000. The tax rules for a transfer involving an annuity issued before April 23, 1987, are a bit more complicated. The transferor of the annuity is taxed on any gains from the annuity in the year the contract was surrendered by the individual receiving the gift, not in the year when the gift was actually made.
Example(s): Mr. Smith wishes to make a gift of an annuity to his daughter Alexandra. Mr. Smith purchased the annuity contract before April 23, 1987. He has paid $12,000 in premiums into the annuity, and the annuity has a cash surrender value of $20,000. Mr. Smith gifts the annuity to his daughter when she reaches age 21. Alexandra does not surrender the annuity until she reaches age 25. Mr. Smith would not be taxed on the gains from the annuity ($20,000 cash surrender value minus $12,000 in premiums paid into the annuity) until the year the annuity was surrendered--four years after he made the gift of the annuity to his daughter.
Natural Person Requirement
Prior to 1986, the earnings within an annuity were tax deferred regardless of whether the owner of the annuity was a natural person. In 1986, Congress enacted legislation that, among other things, prevented corporations and certain entities from benefiting from the tax-deferred treatment granted to annuities. If a contribution is made to an annuity after February 28, 1986 that is owned by a corporation or other entity that is not considered to be a natural person, the earnings each year on the funds within the annuity are generally included in the owner's taxable income. Despite that, the non-natural person rule does not apply when an annuity contract is held by a trust, corporation, or other non-natural person as an agent for a natural person. In other words, the contract will be treated as an annuity, and the earnings within the annuity will be tax deferred. In addition, it is important for those employed with Intel to keep in mind that the non-natural person rule does not apply to certain types of annuities, including any that are:
- Acquired by a person's estate at the person's death
- Held under a qualified retirement plan, a tax-sheltered annuity (TSA), or an individual retirement account
- Purchased by a Intel-sponsored plan upon the termination of a qualified retirement plan or TSA program and held by Intel until all amounts under the contract are distributed to the employee for whom the contract was purchased (or his or her beneficiary)
- An immediate annuity (i.e., an annuity purchased with a single premium that begins payments within a year of the date of the purchase of the annuity and provides for a series of substantially equal periodic payments, to be made not less frequently than annually, during the annuity period)
- A qualified funding asset (i.e., an annuity contract issued by a licensed insurance company that is purchased to fund payments for damages that result from personal physical injury or sickness)
Estate Taxation of Annuities
Generally, the value of an annuity contract is includable in the deceased policyowner's gross estate. If the annuity holder dies before payments begin under the contract, the value of the annuity is equal to the accumulated cash value. If payments have begun at the time of the annuity holder's death, it is the value of the remaining payments, if any, under the contract. If the annuity is owned jointly by individuals who are not married, then the value included in the gross estate is based on each owner's respective contributions. As a Intel employee possibly owning an annuity, you may want to consider this information when conducting future planning and ensuring that your assets go to the designated people upon death.
Example(s): Bill paid 60 percent of the premiums on an annuity, while his cousin Ed paid the other 40 percent. When Bill dies, only 60 percent of the value of the annuity will be included in his gross estate, since he contributed 60 percent of the premiums. When Ed dies, 40 percent of the value will be included in his gross estate.
If the joint owners are married, then half of the value is included in each spouse's gross estate.
Example(s): Bill paid 60 percent of the premium on an annuity, and his wife, Cindy, paid the other 40 percent. When Bill dies, only 50 percent of the value of the contract will be included in his gross estate, even though he contributed 60 percent of the premiums. When Cindy dies, 50 percent of the value will be included in her gross estate even though she only contributed 40 percent of the premiums.
Example(s): However, if an annuity contract is gifted to another person by the decedent prior to death and the decedent did not retain any interest in either the contract or the annuitization payments, the value of the annuity contract generally will not be included in the decedent's estate.
Gift Taxation of Annuities Gifted After the Annuitization Starting Date
As a Intel employee, if you gift an annuity you may have to pay federal gift tax on the value of the gift. If an individual purchases an annuity and then immediately gifts the annuity to another individual, the value of the gift is considered to be the cost of the annuity contract. If the purchaser of the annuity contract holds the contract for a period of time before gifting it to another individual, and additional payments are required to keep the contract in place, determining the value of the gift is a bit more complicated. The value of the gift is equal to the sum of the interpolated terminal reserve value and the proportionate part of the most recent premium payment that covers the period extending beyond the date of death.
Tip: The annual gift tax exclusion may apply.
How does the Intel Pension Plan define the eligibility criteria for employees looking to retire, and what specific steps must they take to determine their benefit under the Intel Pension Plan?
Eligibility Criteria for Retirement: To be eligible for the Intel Pension Plan, employees must meet specific criteria, such as age and years of service. Benefits are calculated based on final average pay and years of service, and employees can determine their benefits by logging into their Fidelity NetBenefits account, where they can view their projected monthly benefit and explore different retirement dates(Intel_Pension_Plan_Dece…).
What are the implications of choosing between a lump-sum distribution and a monthly income from the Intel Pension Plan, and how can employees assess which option is best suited for their individual financial circumstances?
Lump-Sum vs. Monthly Income: Choosing between a lump-sum distribution and monthly income under the Intel Pension Plan depends on personal financial goals. A lump-sum provides flexibility but exposes retirees to market risk, while monthly payments offer consistent income. Employees should consider factors like their financial needs, life expectancy, and risk tolerance when deciding which option fits their situation(Intel_Pension_Plan_Dece…).
In what ways can changes in interest rates affect the lump-sum benefit calculation under the Intel Pension Plan, and why is it essential for employees to be proactive about their retirement planning concerning these fluctuations?
Interest Rates and Lump-Sum Calculations: Interest rates directly affect the lump-sum calculation, as higher rates reduce the present value of future payments, leading to a smaller lump-sum benefit. Therefore, it's crucial for employees to monitor interest rate trends when planning their retirement to avoid potential reductions in their lump-sum payout(Intel_Pension_Plan_Dece…).
How do factors like final average pay and years of service impact the pension benefits calculated under the Intel Pension Plan, and what resources are available for employees to estimate their potential benefits?
Impact of Final Average Pay and Years of Service: Pension benefits under the Intel Pension Plan are calculated using final average pay (highest-earning years) and years of service. Employees can use available tools, such as the Fidelity NetBenefits calculator, to estimate their potential pension based on these factors, giving them a clearer picture of their retirement income(Intel_Pension_Plan_Dece…).
How should employees approach their financial planning in light of their Intel Pension Plan benefits, and what role does risk tolerance play in deciding between a lump-sum payment and monthly income?
Financial Planning and Risk Tolerance: Employees should incorporate their pension plan benefits into broader financial planning. Those with a lower risk tolerance might prefer the steady income of monthly payments, while individuals willing to take investment risks might opt for the lump-sum payout. Balancing these decisions with other income sources is vital(Intel_Pension_Plan_Dece…).
What considerations should Intel employees evaluate regarding healthcare and insurance needs when transitioning into retirement, based on the guidelines established by the Intel Pension Plan?
Healthcare and Insurance Needs: Intel employees approaching retirement should carefully evaluate their healthcare options, including Medicare eligibility, private insurance, and the use of their SERMA accounts. Considering how healthcare costs fit into their retirement budget is crucial, as these costs will likely increase over time(Intel_Pension_Plan_Dece…).
How can employees maximize their benefits from the Intel Pension Plan by understanding the minimum pension benefit provision, and what steps can they take if their Retirement Contribution account falls short?
Maximizing Benefits with the Minimum Pension Provision: Employees can maximize their pension benefits by understanding the minimum pension benefit provision, which ensures that retirees receive a certain income even if their Retirement Contribution (RC) account balance is insufficient. Those whose RC accounts fall short will receive a benefit from the Minimum Pension Plan (MPP)(Intel_Pension_Plan_Dece…).
What resources does Intel offer to support employees in their retirement transition, including assessment tools and financial planning services tailored to those benefiting from the Intel Pension Plan?
Resources for Retirement Transition: Intel provides several resources to support employees' transition into retirement, including financial planning tools and access to Fidelity's retirement calculators. Employees can use these tools to run scenarios and determine the most beneficial pension options based on their financial goals(Intel_Pension_Plan_Dece…).
What strategies can retirees implement to manage taxes effectively when receiving payments from the Intel Pension Plan, and how do these strategies vary between lump-sum distributions and monthly income options?
Tax Strategies for Pension Payments: Managing taxes on pension payments requires strategic planning. Lump-sum distributions are often subject to immediate taxation, while monthly income is taxed as regular income. Retirees can explore tax-deferred accounts and other strategies to minimize their tax burden(Intel_Pension_Plan_Dece…).
How can employees of Intel contact Human Resources to get personalized assistance with their pension questions or concerns regarding the Intel Pension Plan, and what specific information should they be prepared to provide during this communication?
Contacting HR for Pension Assistance: Intel employees seeking assistance with their pension plan can contact HR for personalized support. It is recommended that they have their employee ID, retirement dates, and specific pension-related questions ready to expedite the process. HR can guide them through benefit calculations and options(Intel_Pension_Plan_Dece…).