What a non-may have access to annuity is

A non-may have access to annuity is an annuity you buy with money that has already been taxed — money from your paycheck after taxes were taken out, or money you earned and paid income tax on in a previous year. The IRS calls it "non-may have access to" because it did not come from a tax-advantaged retirement account like a 401(k) or IRA.

When you withdraw money from a non-may have access to annuity, you pay income tax only on the earnings (the growth), not on the original amount you put in. That original amount is called your cost basis, and you already paid tax on it. This is the main difference between a non-may have access to annuity and a may have access to one, where every dollar you withdraw is taxed as ordinary income.

Non-may have access to annuities are sold by insurance companies. You give them a lump sum or make payments over time, and they promise to pay you back over a set period or for the rest of your life, depending on the contract you choose.

Key Takeaways

  • Non-may have access to annuities are funded with after-tax money, so you only pay income tax on the earnings when you withdraw, not on your original investment.
  • The IRS uses a formula called the exclusion ratio to determine how much of each withdrawal is taxed and how much is tax-free.
  • If you withdraw money before age 59½, you may owe a 10 percent early withdrawal penalty on the earnings portion, though some exceptions exist.
  • Non-may have access to annuities have no annual contribution limits, unlike IRAs and 401(k)s, so you can invest as much as you want.
  • Surrender charges imposed by the insurance company can be steep if you need to access your money in the first 5 to 10 years.

How the exclusion ratio determines what you pay in taxes

When you start taking money out of a non-may have access to annuity, the IRS does not let you straightforward withdraw your cost basis first and then pay tax on earnings. Instead, each withdrawal is treated as a mix of both. The exclusion ratio is the formula that splits each payment into the tax-free portion and the taxable portion.

The exclusion ratio is calculated as: your cost basis divided by the total amount you expect to receive over the life of the annuity. If you invested $100,000 and the annuity will pay you $200,000 total, your exclusion ratio is 50 percent. That means 50 percent of each payment is tax-free and 50 percent is taxable income.

This ratio stays the same for the entire life of the annuity. You do not recalculate it each year. If you live longer than the insurance company predicted, you will eventually recover your entire cost basis tax-free, and all remaining payments become fully taxable. If you die before recovering your full cost basis, your beneficiary can claim the unrecovered amount as a loss on their tax return.

Early withdrawal penalties and age 59½

If you withdraw earnings from a non-may have access to annuity before you turn 59½, you owe a 10 percent penalty on the earnings portion of that withdrawal, in addition to ordinary income tax. The penalty does not explore to your cost basis — only to the growth.

The IRS has carved out some exceptions. You can withdraw without the 10 percent penalty if you are disabled, if you use the money for unreimbursed medical expenses that exceed 7.5 percent of your adjusted gross income, or if you set up a series of substantially equal periodic payments (called a 72(t) distribution). You also avoid the penalty if you withdraw after age 59½, or if you are a beneficiary receiving payments after the annuity owner's death.

Surrender charges from the insurance company are separate from the IRS penalty. These are fees the insurance company charges if you withdraw more than a small amount (often 10 percent per year) during the surrender period, which typically lasts 5 to 10 years. Surrender charges can be 5 to 10 percent of the amount withdrawn and are not tax-deductible.

Non-may have access to annuities versus may have access to annuities

The key difference is the source of the money and how withdrawals are taxed. With a may have access to annuity, you funded it with pre-tax dollars from a 401(k), traditional IRA, or similar plan. Every dollar you withdraw is taxed as ordinary income, because you never paid tax on it going in. With a non-may have access to annuity, you already paid tax on the money you invested, so only the earnings are taxed.

may have access to annuities are subject to required minimum distributions (RMDs) starting at age 73. You must withdraw a certain amount each year, calculated by the IRS, or pay a 25 percent penalty on the shortfall (reduced to 10 percent in some cases). Non-may have access to annuities have no RMD requirement — you can leave the money alone as long as you want.

Non-may have access to annuities also have no annual contribution limits. You can invest $50,000, $500,000, or more in a single year if you choose. may have access to plans have annual limits set by the IRS that change each year.

Reporting non-may have access to annuity withdrawals on your tax return

When you receive distributions from a non-may have access to annuity, the insurance company sends you a Form 1099-R in January for the prior year. This form shows the total amount distributed and how much is taxable. The insurance company calculates the taxable portion using the exclusion ratio and reports it to you and the IRS.

You report the taxable portion on your Form 1040 as ordinary income. If you withdrew earnings before age 59½ and do not may have access to for an exception, you also report the 10 percent penalty. This goes on Form 5329, which you attach to your Form 1040.

Keep records of your cost basis — the original amount you invested. If the insurance company makes an error on the 1099-R, you will need documentation to correct it. The IRS can audit the calculation if the numbers do not match what you reported.

When a non-may have access to annuity makes sense

Non-may have access to annuities are useful if you have already maxed out contributions to retirement accounts like a 401(k) or IRA and want to invest more money for retirement. They are also an option if you want a may provide income stream in retirement and do not mind the insurance company's fees and surrender charges.

Some people use non-may have access to annuities to convert a large lump sum (from an inheritance, a business sale, or a settlement) into predictable monthly payments. The insurance company bears the longevity risk — if you live longer than expected, they keep paying you.

However, non-may have access to annuities come with high fees. Surrender charges, administrative fees, and mortality and expense charges can total 1 to 3 percent per year. Before you buy one, compare the may provide payout rate to what you could earn in a diversified portfolio, and understand exactly what you will pay if you need to access your money early.

Frequently Asked Questions

Can I withdraw my cost basis from a non-may have access to annuity without paying tax?

No. The IRS requires you to use the exclusion ratio, which means each withdrawal is a mix of cost basis and earnings. You cannot choose to withdraw only your cost basis first. However, once you have received enough total payments to recover your entire cost basis, all future payments are fully taxable.

What happens to my non-may have access to annuity if I die before I recover my cost basis?

Your beneficiary receives the remaining payments according to the contract terms. If the total they receive is less than your original investment, they can claim the unrecovered cost basis as a loss on their tax return in the year they receive the final payment.

Do I have to take money out of a non-may have access to annuity at a certain age?

No. Unlike may have access to retirement accounts, non-may have access to annuities have no required minimum distributions. You can leave the money in the annuity as long as you want. However, check your contract — some annuities require you to start taking payments at a certain age or after a certain number of years.

Is the 10 percent early withdrawal penalty the same for non-may have access to and may have access to annuities?

The penalty rate is the same — 10 percent — but it applies differently. On a non-may have access to annuity, the penalty applies only to the earnings portion of the withdrawal. On a may have access to annuity, it applies to the entire withdrawal amount, because the entire amount is taxable.

Can I move money from a non-may have access to annuity to another investment without triggering taxes?

No. Withdrawing money from a non-may have access to annuity to move it elsewhere is a taxable event. You will owe income tax on the earnings portion and may owe the 10 percent penalty if you are under 59½. Some annuities allow you to exchange one annuity for another under Section 1035 of the tax code without triggering when ready tax, but this is a specific transaction — ask your insurance company whether your contract allows it.