Financial Advice for Retirement, Social Security, IRAs and Estate Planning

New Tax Break for Annuities

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The IRS in a recent ruling handed a break to annuity owners who are under age 59 1/2 and need cash. The ruling allows these annuity owners to restructure payments they receive from the annuities.

Until the ruling, annuity owners had only one opportunity to determine the payment stream to take before age 59 1/2. The IRS said that to avoid the 10% early distribution penalty, annuity owners under age 59 1/2 had to establish a payment schedule and stick with it. The distributions had to be a series of substantially equal payments. If the payment schedule were changed, the owner had to pay the 10% penalty plus interest on all previous distributions.

Now, Revenue Ruling 2004-15 says that the payment schedule can be changed. Owners of tax-qualified annuities (such as 403(b) plans and pension annuities) have been allowed to switch distribution methods since 2002. The IRS decided that owners of non-qualified annuities (such as insurance annuity contracts) should have the same rights.

The change should be helpful because of the market volatility of the last few years. Some people began payments before the bear market, when their annuity values were much higher. They’d like to reduce the payments so the annuity won’t be depleted early. Others saw their annuities grow in the market recovery and would like to increase payments to reflect the new values.

Annuity owners still must choose between the three methods for calculating substantially equal payments in Revenue Ruling 89-25: required minimum distribution method; fixed amortization method; and fixed annuitization method. The methods can result in very different distributions, so an annuity owner should re-examine the choices as his or her needs change.

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