How to represent qualified, non-qualified, and variable annuities in your plan, including the tax treatment of withdrawals and annuitized payments
The Planner doesn't have a dedicated annuity-tax feature, but its flexibility lets you model any annuity accurately once you know its value and how it's taxed. How you model it depends on how the annuity was funded and how you take the money out.
If you just want to enter a straightforward annuity as an income stream, see How to enter an annuity. This article covers the tax modeling for the cases the annuity feature can't capture on its own.
Qualified annuities (bought with pre-tax dollars)
If you bought the annuity inside a 401(k) or traditional IRA, enter it as an Other Pre Tax account. The Planner will model RMDs on the account, and all withdrawals are taxed as ordinary income.
Non-qualified annuities (bought with after-tax dollars)
With a non-qualified annuity, your contributions come back tax-free and only the earnings are taxable, as ordinary income. How the taxable and tax-free portions are calculated depends on whether you take partial withdrawals or annuitize.
Before annuitizing — partial withdrawals (LIFO)
Before you annuitize, partial withdrawals are taxed last in, first out: earnings come out first and are taxed as ordinary income until all earnings are gone. After that, withdrawals are a tax-free return of your contributions.
Model this in three parts.
1. A contributions (cost basis) account
Navigate to My Plan > Assets and Debts
Add an Investment, Savings, or Checking account
Set the balance equal to the current cost basis of your annuity
Select Ordinary Income tax treatment
Set the rate of return to 0%
Exclude the account from your withdrawal strategies
Please note: This account represents the contributions you've made to your annuity, which are non-taxable. If you're still contributing and this wasn't a lump-sum purchase, model ongoing contributions as transfers into this account from an after-tax account, with the appropriate amount and start/stop ages. Confirm the contributions are funded and adjust as needed.
2. An earnings withdrawal, taxed as ordinary income
Create a pension equal to the amount of earnings you plan to withdraw, with start and stop ages, 0% COLA, taxable set to Yes, and survivor benefit 100%.
Please note: This represents the earnings-first (LIFO) withdrawal, taxed as ordinary income, that happens before any return of contributions.
Estimating your earnings: Your withdrawable earnings equal your annuity's projected value at your payment age minus your total contributions. Your provider or statement is the best source for projected value, but you can also estimate it in the Planner: temporarily set the contributions account to your expected rate of return and read its balance at your payment age in Savings > Insights (value including growth), then read it again at 0% return (your total contributions). The difference is your earnings. Reset the account to 0% return when you're done.
3. Return of contributions, tax-free
Once all earnings have been withdrawn, further withdrawals are a tax-free return of your contributions. Model these as a transfer from the contributions account to your desired after-tax account.
After annuitizing — the exclusion ratio (two pensions)
When you annuitize, each payment is split into a taxable portion (earnings) and a tax-free portion (return of contributions), set by the exclusion ratio in your contract. Model this with two pensions:
Non-taxable pension — name it so it's clearly the non-taxable portion; income equal to the non-taxable part of each payment; start and stop ages; COLA as specified in your policy; taxable set to No; your survivor benefit amount
Taxable pension — name it so it's clearly the taxable portion; income equal to the taxable part of each payment; start and stop ages; COLA as specified in your policy; taxable set to Yes; your survivor benefit amount
Please note: Two pensions are needed because annuitized non-qualified payments are split by the exclusion ratio — one part taxable earnings, one part tax-free return of contributions.
Variable annuities
Variable annuities are modeled the same way. The Planner doesn't have a dedicated variable-annuity section, but as long as you know the annuity's value and how it's taxed, you can model it with the qualified or non-qualified steps above, depending on how it was funded.
FAQs
Which method do I use — qualified or non-qualified? It depends on how the annuity was funded. Pre-tax or tax-deductible dollars (for example, an annuity inside a 401(k) or traditional IRA) → qualified. After-tax dollars → non-qualified.
Why are two pensions needed for an annuitized non-qualified annuity? Because each payment is part taxable earnings and part tax-free return of contributions. One pension carries the taxable portion, the other the non-taxable portion, matching your contract's exclusion ratio.
How do I model a variable annuity? The same way as any annuity — use the qualified or non-qualified steps above based on how it was funded. There's no separate variable-annuity feature; you just need the value and the taxation.