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Question for the Money Doctors

Question submitted on Mar 22, 2014.

Question

I purchased a nonqualified annuity in 1992 with a $15,000 initial investment. Over the years it had grown to around $36,000. I just purchased a house and need some extra money to remodel the kitchen, so I contacted Nationwide Life Insurance and they said there would bo no penalty (it had matured) or taxes on on my initial investment. I withdrew $12,000, and when I received the 1099 R, it seems that this amount is taxable. I was 60 years at the time, so there would be no 10% penalty. Why am I being taxed on the after tax investment, and why did not anyone at Nationwide alert me to this fact. Is there a way around this that I don't know about?

Answer

First, a nonqualified annuity is an annuity that is not inside an IRA or other qualified retirement plan. So, nonqualified annuities are available to anyone, regardless of income. Since nonqualified annuities are not part of any qualified retirement plan, you can not deduct your contributions from your current income for tax purposes.
You can take a distribution from your nonqualified annuity either as a withdrawal or as annuitization of the contract. The tax laws require that if any part of the annuity is taken as a withdrawal, contract gains are assumed to be distributed first and this gain is taxed as ordinary income tax. Only after all gains are withdrawn will the non-taxable return of principal be assumed to be distributed. If taken as an annuity, part of each payment would be considered a return of principal (non-taxable) and part gain (taxed as ordinary income).
There is no way to "undo" this withdrawal and unfortunately, someone should have told you this prior to your withdrawal.


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