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The past couple of years, the stock market hasn’t been anybody’s friend. The stock market was down more than 50% and many boomers are feeling the pinch as retirement nears (or already has). I’ve you’ve bought investments (stocks, mutual funds, ETF’s) in a taxable account and now they’re down, at least you can get the capital loss. It’s not as good as getting your money back, but it will have to do. Many boomers, though, have bought variable annuities that have also taken a hit. Being tax deferred investment vehicles, the ability to write these off is a bit more complex. For any boomers or investors that have lost money in an annuity, we’ll look to answer the question, “Can you take a loss on your annuity?”.
Taking a Tax Loss on an Annuity
The typical loss that an investor is allowed to take is called a “capital loss”. This loss allows you to deduct up to $3,000 per year as a tax deduction. If you have a loss greater than $3,000 then there is indefinite carry over. That means if you lost $50,000 in one year you could write it off $3,000 per year until the entire $50,000 loss was used. Any losses in addition to the $50,000 would just be added onto the amount. It’s kind of like a tax coupon that never expires.
But what about on an annuity? The loss is not a capital loss, meaning that it’s not a $3,000 tax deduction. The loss will be treated as a miscellaneous itemized deduction on Schedule A, where only the part of the loss that exceeds 2% of your adjusted gross income.
How do You Take a Loss?
In order to take the loss, you have to surrender your annuity. This means you have to cash out of the annuity and use your funds for another type of investment. Make sure you call the annuity company first to verify if there are any surrender charges remaining on the contract. If there is a surrender penalty on the contract, that amount will be allowed to be used as a tax deduction.
Annuity Loss Example
Boomer Johnson bought a non-qualified annuity five years ago for $10o,000. The annuity has had anything from a stellar performance and is now worth only $75,000. To add insult to injury, there is a surrender charge of $4,000. Despite the surrender charge, Boomer Johnson has had enough and decides to cash out his annuity and receives a check for $71,000. Even though Boomer Johnson received a check for only $71,000, his actual realized loss on the annuity is only $25,000, since the surrender charge of $4,000 cannot be used as part of the loss.
Is There a Penalty if not 59 1/2?
Annuities, like other retirement accounts, have the 59 1/2 age restrictions on when you can touch the money. In the event of a loss, however; the investor will not have to pay the 10% early withdrawal penalty.
What about a 1035 Exchange?
Double-check on the original cost basis if a 1035 exchange was involved. If you have an annuity that was purchased many years ago and since then you have 1035 or exchanged it into a new contract, the cost basis we based on the original purchase amount of the initial contract, not on the current one that you hold. This is very important to double-check to prevent having to pay ordinary income tax and possibly a 10% early withdrawal penalty.
Does it Make Sense to Surrender Your Annuity?
It sure can. If you have an inferior product with crummy investment selections, it makes complete sense to to dump it and move on. Before you do so (as noted above), call the insurance company and make sure there aren’t any surrender charges or any other benefits that you might be losing if you cash out.