Aggregation Rules on Annuities

Annuities are financial products issued by life insurance companies. An annuity pays a fixed or variable rate of interest depending on the contract terms. The annuity also offers the investor the option of guaranteed income through annuitization. Annuitization turns your annuity savings into monthly payments that can extend for your entire life or for a specified period of time. If you opt to avoid annuitization in favor of withdrawals, understand that IRS aggregation rules will treat all of your nonqualified deferred annuities as a single annuity for withdrawal purposes.

The IRS will treat all of your nonqualified annuities as a single annuity for withdrawal purposes. This means that any annuity that is not inside of a qualified account, like an IRA, will be treated as a single annuity. Immediate annuities are excluded from the aggregation rules. When you withdraw money from any of your nonqualified annuities, the IRS treats your withdrawal as a withdrawal of interest, regardless of the actual interest income inside the annuity. This means that if you have a total of $100,000 in five different annuities, and one of the annuities has only $5,000 of interest income earned but another annuity has $10,000 of interest and you want to withdrawal $7,000 from your annuity, it doesn't matter which annuity you withdraw your money from. Even if you withdraw money from the annuity with $5,000 interest earnings, the IRS will not consider the additional $2,000 as principal. Instead, it will treat the entire amount as interest earnings.

A common misconception is that you can withdraw money from the lowest yielding annuity to avoid or minimize income tax due on withdrawals from annuities. This is not true for nonqualified annuities. Your income tax would remain the same regardless of withdrawals.

To avoid the aggregation rules on nonqualified annuities you must annuitize the contract and convert your annuity savings to a monthly, quarterly or annual income stream. Alternatively, you need to use qualified retirement accounts and purchase annuities inside of these accounts.