Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question: Another agent is telling my client there is some chance of a 10% penalty upon surrendering an annuity he sold her, even though there has been no 10% penalty on her withdrawals over the last three years.  What could he be referring to?

Answer: We can’t be sure if the 10% penalty is a surrender charge or a penalty tax.  Let’s address the surrender charge possibility first.  Many annuities allow a client “free access” to up to 10% of the account value every year without incurring a surrender charge.  However, if the whole annuity is cashed in, surrender charges could apply—and it’s possible that the surrender charge might be 10%.  So that might be the answer.

There have been plenty of new deferred annuity designs over the past several years.  Most of them develop traditional cash values, but also develop a richer “retirement income” account that is available if the client accesses the account in a certain way.

That leads to the tax possibility.  Taxation of nonqualified annuities is pretty straightforward.  Cash taken from them is taxed on a gain-first basis.  Gain is measured by comparing the contract’s cash value to basis.  Any taxable distribution of gain is also usually subject to an extra 10% penalty tax for those younger than 59 ½.

A complete surrender could trigger some kind of bonus payment that generates extra taxable gain on part of the surrender proceeds.  If that’s true, the gain portion (and only the gain portion) will probably be hit with the penalty tax if the client’s younger than 59 ½.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.