A reader recently had a question about taxes on tax-deferred annuities. Here’s what she asked: “I bought a tax-deferred annuity from my bank back in 2003. The broker there said I would never have to pay income tax on it as long as I didn’t remove any of the money. Recently I asked him if my beneficiary, my niece, would have to pay income tax on it when I die. He said no, she wouldn’t have to worry about income or estate taxes. Was he right? My neighbor said the broker doesn’t know what he’s talking about. Please help me understand this. Thank you, Beth.” And here is my answer: “Beth, I’ll assume the annuity is not owned inside your IRA and you are the owner. As far as your niece goes, she’ll have to pay income tax on the gain within the annuity but not the amount you had invested. For example, if you had invested $50,000 and the annuity is worth $75,000 on your date of death, your niece will have to declare the $25,000 in profit as ordinary taxable income. Unfortunately, there is no capital gains break for annuities. “Not knowing the size of your estate, I can’t tell you whether your niece will have to worry about estate taxes. I can tell you, though, that the annuity will be included in your estate. So it sounds like your neighbor is more up on things than your broker!” What can you learn from this: Get a second opinion before making investment decisions. Best wishes, George
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