The Impact of the New Tax Bill on Annuities

The highly anticipated Tax Cuts and Job Act signed into law in December 2018 is the most significant tax legislation enacted since the 1980s. Most taxpayers across the spectrum – both individual and business – come out ahead with the reduction in tax rates, the increase in the standard deduction, and the business income deduction for many small businesses. The tax treatment of investment income from capital gains and dividends is left untouched. The tax advantages of annuities, long considered a target of policymakers as a source of new tax revenue, also escaped unscathed. For now, annuities maintain their tax-favored status and remain a viable investment option and planning tool for many different purposes.

You Still Need to Watch Out for the Social Security Tax Trap

Many retirees will benefit from lower tax rates. However, nothing has changed with regards to the taxation of Social Security benefits, which can be as high as 50% on combined income between $25,000 and $34,000 for individuals and between $32,000 and $44,000 for couples. The tax rate on Social Security benefits can reach 85% when those income levels are exceeded.

The income from a non-qualified annuity is exempt from the combined income calculation used to determine the taxability of Social Security benefits. In addition, the income from a non-qualified annuity is only partially taxable because a portion of it is considered a return of principal, which could help to avoid tax bracket creep.

Even if you are not taking income from your investments, you can benefit from the tax deferral available from a fixed deferred annuity. If you have some money invested in a certificate of deposit and you are reinvesting the interest, that interest is included in your Social Security tax calculation. By transferring it to a deferred annuity, the interest earned is exempt from the calculation. You can control when you take withdrawals from the annuity so they can be taken in years when your income is low. Or, you can annuitize it at any time when you want to start a lifetime stream of guaranteed income.

Under the New Tax Law Annuities are as Relevant as Ever

The major effect of the new tax law is the reduction in federal income taxes paid by individuals, couples and businesses.  Anytime taxes are lowered, it has the potential to take some of sheen off of tax advantages investments such as annuities. However, not only do annuities still retain their tax advantages, they also retain their unique properties, such as guaranteed lifetime income, protection from creditors and claims, and an income exemption from Social Security taxes, making them an important planning tool in many situations.