When you are looking for a great way to invest your money, you should make an effort in learning about annuity. For example, some people might have the notion that this type of investment helps you evade taxes. This way of thinking is true in some aspects but not entirely. It is true that you will not pay taxes on the interest that your money earns during the accumulation period. Therefore, your money grows at a rate that is higher than that of a taxed method of investment. This type of annuity is called the deferred annuity. However, it comes to the point as agreed on the insurance contract when you start withdrawing your money. This is the time that you will start paying some taxes. Nevertheless, how does it happen?
To begin with, you have to know that there are two ways of receiving payments from this scheme. You can receive them in a single lump sum or as periodic payments over an agreed duration. The latter is referred to as annuitization in professional terms. You need to learn about such terms in the process of knowing what is annuity.
With the option of receiving a lump sum, you will pay taxes on the interest amount. Therefore, you will get the money you deposited into your account in the same amount. The argument is that this money had already been taxed before you put it into this scheme; hence there is no need for a second deduction. However, all the interests gained will attract some taxes. Moreover, it would be incorrect to predetermine these deductions. This is because the value will be computed with the current income tax rate.
With the case of annuitization, computation will be almost the same with the above scenario. Every amount that you receive will have a portion of your principal plus the gained interest. The periodic amount is a result of dividing your principal amount by the total number of payments that you will receive. However, for the amount that will be in addition to the principal payment, you will have to pay the ordinary income taxes at the current rate. The same case will apply to the variable annuities. This is despite the fact that they will gain interests at a changing rate.
On the same note, if you understand what is annuity, you will know that there is the possibility of naming a beneficiary. Therefore, what is the tax policy for the payments made to this person? The beneficiary will receive tax-free money up to the time that all payments equals the amount invested by the deceased. However, for the amount gained during the accumulation phase, the beneficiary will be taxed at the rate of any other income.
In the event whereby the annuitant passes on before receiving any payment, then the beneficiary will be subject to taxation as per the terms and conditions. This is irrespective of whether the payments are made as a lump sum or as periodic payments. In the case of a lump sum, he will pay taxes on the money that is gained on top of the principal amount. However, if he will receive periodic payments, then taxation will begin after this principal amount is fully settled. Taxes are imposed just as they are on ordinary income.