What is Joint Annuity Taxation?
Because of changes to the tax code in 1986, it's no longer tax advantageous to jointly own an annuity. Joint ownership is regarded as joint tenancy with right of survivorship, which can complicate administration and have unintended tax consequences for the owners. Passing an annuity to a spouse or child is usually better achieved by naming them as beneficiaries rather than joint owners. However, because each individual's circumstances are different, you should consult with your tax, investment and legal advisers before your purchase an annuity.
Pre-1986 Tax Advantages
Prior to 1986, a parent could buy an annuity, name a child as joint owner and select one of the child's birthdays as the maturity date -- when the child turns 70 years old, for example. When the parent died, the money passed to the child outside of probate, and the parent never paid tax on the money earned by the annuity. The child could also defer tax past his own lifetime if he named another joint owner.
The Tax Reform Act of 1986
The Tax Reform Act of 1986 changed the joint annuity taxation rules to prevent using joint ownership as a way to defer paying tax over more than one lifetime. Unless the joint owners of an annuity are married, if they haven't started taking withdrawals and one of the owners dies, the entire interest in the annuity must be distributed to the surviving owner within five years of the other owner's death. A surviving spouse can continue to defer taxes as if she were the sole owner of the annuity since its purchase.
Parent-Child Joint Ownership
If you purchase a joint annuity for you and your child, you own equal shares. A withdrawal requires two signatures, and a distribution check is made out to both of you. If you paid the entire premium to purchase the annuity, you just gave your child a taxable gift equal to one-half the premium. If you need to make a withdrawal for financial reasons, one-half of the withdrawal is taxable income to your child, regardless of who uses the money. If she is under age 59 1/2, she must pay a 10 percent penalty on her portion of the withdrawal.
Beneficiary Vs. Joint Owner
When a married couple jointly owns an annuity and one spouse dies, the surviving spouse can continue to defer taxes during her lifetime. However, the couple can achieve the same result and avoid the complications of joint tenancy by naming a spouse as the beneficiary of the annuity. A surviving spouse who is the beneficiary of an annuity becomes the annuity owner when the owning spouse dies. If a married couple wants the annuity to pass to their children, they can designate their children as contingent beneficiaries. The children, however, must take distribution within five years of the last parent's death.
Steve McDonnell's experience running businesses and launching companies complements his technical expertise in information, technology and human resources. He earned a degree in computer science from Dartmouth College, served on the WorldatWork editorial board, blogged for the Spotfire Business Intelligence blog and has published books and book chapters for International Human Resource Information Management and Westlaw.