Which account should I withdraw from, my IRA or my annuity?

August 05, 2015 by Dave Du Val, EA
Glass globe on financial statements

Hey Dave,

I’m hoping you are relaxing somewhere with an umbrella drink after tax season. My wife and I are considering installing a solar electrical system on our house and on our studio building. We have an IRA and we have an Annuity with Hartford (the latter which we have a monthly income from). We are contemplating putting our hands on the cash to afford to pay for the solar system. To my mind both a distribution from the IRA (my wife is 67 and I am 73 but it is her IRA) and a withdrawal from the Hartford Annuity are both taxed the same, but I’m not sure. We are trying to determine if there would be any difference in the nature of the taxable income between the two, which might point us to the smartest choice of accounts to withdraw from. I continue to be an evangelist for TaxAudit.com.  I can’t understand why everyone wouldn’t want to have your program in place every year.

Sal

 

Sal,

This is an excellent question, and the answer can get to be a bit complicated. The withdrawal may be taxed the same, and then again it may not. It really depends on the type of IRA and annuity, and whether you have basis (after-tax contributions) in either. For instance, if your wife’s IRA is a traditional IRA and she has no basis in it (i.e., all of the contributions were made with pre-tax money, or the contributions were deducted on your return), then the entire amount of the distribution would be added to your taxable income in the year of the distribution.

While some taxpayers have basis, most do not. If your wife has basis, then the amount that is taxable would be determined by calculating a percentage. This percentage is figured by the total amount in basis in all of her traditional IRAs divided by the total value in all of her traditional IRAs. TurboTax will do this calculation for you when you properly answer all of the related questions during the interview.

How your annuity is taxed will depend on whether it is a qualified annuity or a nonqualified annuity. If it is a qualified annuity it is taxed the same way as a distribution from the same type of retirement plan that is not held in an annuity. A qualified annuity can include employer retirement plans and IRA accounts. On the other hand, if it is a nonqualified annuity and the contract was entered into after August 14, 1982, from any distribution earnings are taxed first, and then amounts from contributions.

Your contributions in a nonqualified annuity generally are the amount you originally contributed, plus any additional contributions made. What this means is that you will pay tax on the distribution up to the amount that is earnings within the annuity. If the distribution is greater than the earnings, any amount above the earnings is a nontaxable return of contributions. The insurance company may be able to tell you how much of any distribution will be taxable, so we recommend checking with them first before taking any withdrawal.

Remember also that when taking a withdrawal (not annuitized) distribution from an annuity the insurance company may charge you surrender charges. While this is not a tax, it certainly increases the cost of your access to the money.

To sum this up, the taxation of the distributions will likely be the same if your wife has no basis in her traditional IRA(s), and if the annuity is a nonqualified annuity and the distribution represents only earnings. A qualified annuity may be taxed the same, depending on the type of qualified annuity. But without knowing the specifics of your IRA, and without knowing the specifics of your annuity contract, there is no way to provide you with a definite answer.

And thank you for being an evangelist for TaxAudit.com!

Deductibly Yours,

Dave

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David E. Du Val, EA
Chief Compliance Officer for TRI Holdco

 

Dave Du Val, EA, is Chief Compliance Officer for TRI Holdco. Inc., the parent company of TaxAudit, and Centenal Tax Group. A nationally recognized speaker and educator, Dave is well known for his high energy and dynamic presentation style. He is a frequent and popular guest speaker for the California Society of Tax Consultants, the California Society of Enrolled Agents and the National Association of Tax Professionals. Dave frequently contributes tax tips and information to news publications, including US News and World Report, USA Today, and CPA Practice Advisor. Dave is an Enrolled Agent who has prepared thousands of returns during his career and has trained and mentored hundreds of tax professionals. He is a member of the National Association of Tax Professionals, the National Association of Enrolled Agents and the California Society of Enrolled Agents. Dave also holds a Master of Arts in Education and has been educating people since 1972. 


 

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