Taxability of distributions from a non-qualified annuity


J

Julian

Is a portion of my annual distributions from "Safe Money"
annuities tax deductible ??

I have 3 variable annuity contracts with Hartford insurance
, non-qualified, which I bought thru Smith Barney. They pay
me about $4300 year in monthly installments [I also have a
sep ira annuity contract with them, whose distributions are
I believe all taxable]. I am 63 years old, and began taking
money out of the contracts in "like and equal" payments in
2005. A few months later, I converted all the contracts to
"safe money" contracts, in which I have to take the money
out over a period of 14 years [in equal monthly
installments]. After 5 years, however, if I wanted to, I
could "re-up " the contracts for another 14 years..so if the
market does well, and what I have left after 5 years of
distributions/appreciation would give me the same or greater
distributions, I can extend the contracts for another 14
years. I can never get less than what I put in, even if the
market tanks to zero-which is why they are called safe money
contracts. My broker also says that I could cancel the
contracts and draw the money out..presumably like a CD with
a penalty. I pay , i think 1/2 of 1% of the value of the
contracts for the "insurance" part, by which i can never get
less than what I put in.

My broker says that all of the distributions on the
non-qualified contracts are tax deductible until all of the
appreciation is paid out to me, and at that point they start
paying out return of principle for tax purposes, and, she
said they operate on a LIFO basis [the principle, or
contribution being filo--first in, last out], so the 1099
will show all as taxable... does lifo apply to these??

I understand I cannot use the simplified method of
"amortizing" the principle I contributed over the 14 years
as this is non-qualified money, but cant I use the General
method in IRS pub 939 to begin deducting a portion of my
contributions?? If so, can I make up for the several years I
did not deduct non taxable portions of the distributions by
dividing the contribution by the number of years left on the
contracts....which is 12 I think [in any case, the whole
amount of the contributions are deducted over whatever
period, there is nothing left to deduct from any
distribution, regardless of how much is left at the end of
the contract due to appreciation]??

My stockbroker says that unlike lifetime annuities in which
I cant cash out, these annuities are dealt with for tax
purposes on a lifo basis..ie., all the money coming out is
taxable until I get down to my contributions to them, and
then I start getting the money back tax free

However , they are annuity contracts, and at pg 26 of the
IRS `book of forms and instructions for the form 1040, there
is the simplified method for calculating the tax free
portion of annuity distributions ...which allows you to
amortize your contribution as a tax free portion of the
distribution over the number of months in your remaining
life expectancy. In doing research on the web..IRS.gov,
pub 939 it appears I cannot use the simplified method on the
worksheet, but may be able to use the general method for non
qualified plans. Essentially dividing my cost of the
contracts by the life [14 years] , and that is how much I
can deduct as a non-taxable distribution , although I let
last year go buy without doing this. Is my broker right that
I can not deduct anything until all of the appreciation is
returned ..ie, the lifo method, or can I start amortizing my
cost over the 13 years remaining??

Thank you

Julian Greenspun

Rockville, MD
 
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