| Annuity Glossary |  Printer-friendly version |
Annuitization: When you annuitize your contract, you trade the value of your contract for the issuing company's guarantee to make payments to you periodically for a certain period, or for your lifetime.
Annuity: A contract issued by a life insurance company that provides for tax deferral of investment income until withdrawn from the contract. Variable annuities offer a choice of investment options.
Backup Withholding: Backup withholding is mandatory withholding that may be imposed when rules regarding taxpayer identification numbers (usually a Social Security number) are not met by the individual, or when a notice is issued by the IRS to withhold on payments to that individual. Backup withholding may be claimed as a credit by taxpayers on their federal income tax return.
Collateral Assignments: A collateral assignment is when the ownership rights in a contract or account are transferred from one person to another to serve as collateral for a debt. This transfer is usually made with the provision that the ownership rights revert to the original owner when the debt is repaid. A collateral assignment of a nonqualified annuity is considered a taxable event to the owner of the contract.
Cost Basis: Your initial payment/premium(s) paid to a nonqualified annuity is known as the cost basis in your contract. Since it was previously taxed, your cost basis will not be taxed upon withdrawal. If a previous distribution was not fully taxable, the cost basis would be reduced by the amount that was not taxable. For contracts purchased after August 14, 1982, a "withdrawal" must come from earnings first for tax purposes, and any amounts in excess of your cost basis will be taxed as ordinary income (an additional 10 percent "federal income" tax penalty may apply for those less than 59 1/2 years of age) upon withdrawal.
Cost of Insurance PS58: When life insurance protection is used to fund benefits in a qualified retirement plan or Section 403(b) tax-deferred annuity, the contributions used to pay the life insurance premiums must be included in gross income for the year in which they are made. Prudential reports the cost of insurance as a service to its contract owners.
Cost of Waiver: Waiver of premium is a benefit available on qualified life insurance contracts that provides for the waiver or payment of premiums that fall due while the insured is totally disabled. Under a qualified retirement plan, contributions used to purchase waiver of premium benefits are taxable to the plan participant and must be included in gross income in the year in which they are paid.
Direct Rollover: This is when an eligible qualified retirement plan or Section 403(b) distribution is moved directly from a qualified retirement plan or Section 403(b) tax-deferred annuity to an IRA or to another qualified retirement plan or Section 403(b) tax-deferred annuity. The individual's employer will not have to withhold 20% for federal income taxes from a direct rollover.
Distribution Reason Code: The distribution code is located in Box 7 of Form 1099-R. The distribution code indicates to the contract owner whether or not he or she may be subject to a 10% additional tax for early distribution. A Distribution Code 1 means that the contract owner is under age 59 1/2 and no other exception applies. A Distribution Code 7 means that a normal distribution took place and no additional tax will be imposed. A full description of all distribution codes is listed on the back of the form you receive.
Employer Plan or Qualified Plan: A tax-qualified retirement plan an employer establishes to benefit employees. Permissible contributions will depend on the type of plan (such as a defined benefit plan or a profit-sharing plan, including a Section 401(k) plan) and on what the particular employer elects. These plans are highly regulated and subject to significant IRS restrictions.
Exchange (1035): A 1035 exchange is an exchange of one nonqualified contract for another. Internal Revenue Code (IRC) Section 1035 generally allows individuals to exchange life, endowment, or annuity contracts for similar contracts that are better suited to their needs, if eligibility requirements are met. For a 1035 exchange, the contract owner and the insured or annuitant combination on the old and new contract must be the same.
Excess Contributions to an IRA: An excess IRA contribution is one that exceeds the combined deductible and nondeductible limits established by the IRS. If an excess contribution is not removed prior to the tax return due date (including extensions) by the contributing individual, the excess contribution is subject to the 6% excise tax in the year of contribution. The excess will be carried over and subject to excise tax each year thereafter until it is removed. It is the responsibility of the client to file Form 5329 to calculate his or her penalty.
Exclusion Ratio: (Nonqualified Income Annuity.) This is the ratio that determines which portion of an annuity distribution is earnings and which portion is a return of your original investment. Only the portion consisting of earnings is taxable.
Individual Retirement Account (IRA): An IRA is a tax-advantaged personal savings plan that lets an individual set aside money for retirement. All or part of the participant's contributions may be tax deductible, depending on the type of IRA chosen and the investor's personal financial circumstances. Distributions from many employer-sponsored retirement plans may be eligible to be rolled into an IRA to continue tax-deferred growth until the funds are needed.
Interest-Only Option: A settlement option for annuities in which an individual is paid only the interest on the maturity proceeds. A Form 1099-R is issued in the year the annuity matures, and will report any taxable gain. From that point on, the owner receives interest on the maturity proceeds left on deposit.
"Nonqualified" Deferred Annuity: A contract that provides for tax deferral of investment income until withdrawn from the contract. Fixed annuities offer a fixed rate of return for a stipulated period, while variable annuities offer a choice of investment options.
"Nonqualified" Income Annuity: A contract that provides periodic payments based on life or joint life expectancies and/or a period certain (i.e., life and 10 years certain). The periodic payment amount is based on the amount used to purchase the contract, the terms of the payout, and an assumed rate of return.
Nonresident Alien (NRA): A person who is not a citizen of the United States or does not maintain a tax residence within the country. NRAs are subject to special tax consideration. NRAs also include foreign fiduciaries, foreign partnerships, and foreign corporations. Form W-8 (BEN, ECI, EXP, IMY) has to be obtained from all persons claiming NRA status. For individuals, Form W-8 BEN will generally be the appropriate form. Payments to properly documented NRAs are generally exempt from IRS 1099 reporting and backup withholding rules. However the tax law requires 30% NRA withholding rate. Special Internal Revenue Code (IRC) provisions or income tax treaties may reduce or eliminate this withholding. Note: The old IRS Form W-8 will expire on December 31, 2000. You must file a new Form W-8 (BEN, ECI, EXP, IMY) before January 1, 2001, to be treated as an NRA.
Premature Distribution: (Premature Distribution Penalty.) Withdrawals made from certain tax-favored plans may be subject to an additional 10% federal income tax if the withdrawal is made before the contract owner reaches age 59 1/2. Certain exemptions do apply. The contract owner should seek legal and tax advice before making plan withdrawals.
Premium Taxes: Some states charge a tax on the contributions made to an annuity. The issuing company generally charges the annuity contract for any premium tax and other taxes based on premium it pays to the state.
"Qualified" Annuities: These are annuities purchased for funding an IRA, 403(b) tax-deferred annuity, or other type of retirement arrangements. Tax deferral is provided by an IRA or qualified retirement plan. An annuity contract should be used to fund an IRA or qualified retirement plan to benefit from an annuity's features other than tax deferral, including the lifetime income payout option, the death benefit protection and, for variable annuities, the ability to transfer among investment options without sales or withdrawal charges.
Qualified Retirement Plan: Qualified retirement plans are generally any plan or arrangement eligible for special federal income tax treatment. Examples of qualified retirement plans include 401(k) plans, profit-sharing plans, IRAs, etc.
Retirement Plan Withholding: A distribution to an employee from an employer-sponsored retirement plan is generally subject to a mandatory 20% withholding for federal income taxes (unless the distribution is $200 or less). No withholding is necessary if the funds are directly rolled over into an IRA or other qualified retirement plan. Other rules apply to periodic distributions.
Rollover: A rollover is a distribution from a qualified retirement plan or Section 403(b) to an individual and then from the individual to another qualified retirement plan, Section 403(b), or IRA. After constructive receipt of the distribution, an individual has 60 days to roll the funds over into another qualified funding vehicle in order for the funds to remain qualified. (If the funds are distributed from a qualified plan or Section 403(b) tax deferred annuity, mandatory withholding will take place at a rate of 20%.)
Roth Conversion: You can roll over funds from a traditional IRA to a Roth IRA if you meet certain requirements. The taxable amount of the rollover funds will be included in the gross income for the year in which the conversion is made. If the conversion occurred in 1998, the taxable amount can be spread out over four years.
Roth IRA: A special type of IRA under which distributions may be tax exempt. Individuals may make nondeductible contributions into a Roth IRA if certain income requirements are met. Qualified distributions from a Roth IRA are tax free.
Simplified Employee Pension (SEP): A simplified employee pension is a written arrangement or program that allows an employer to contribute tax-deductible dollars toward an employee's retirement. A SEP may be established by a corporate or noncorporate employer. From an individual's perspective, a SEP has the administrative simplicity of an IRA, but also allows the employer to make contributions on the employee's behalf in addition to the employee's annual contribution limit.
Transfer: A tax-deferred exchange of funds in the same market:
- IRA to IRA
- 403(b) to 403(b)
- IRA/SEP to IRA
- Pension plan to pension plan
Trust or Corporate Owner IRC Section 72(u): If an annuity is issued after February 28, 1986, to a trust or corporation, the income earned on the annuity must generally be reported yearly. Generally, private individuals only report income at the time the annuity matures or a distribution occurs. Please refer to IRC Code Section 72(u) or consult your tax or legal adviser for more information.
Uniform Gifts to Minors Act/Uniform Transfers to Minors Act (UGMA/UTMA): This allows gifting to the name and taxpayer identification number of a minor. It may provide a tax benefit because some or all of the income produced by the investment may be taxed at the rate for the minor's presumably lower income.
Neither Prudential nor its sales professionals render tax or legal advice. Please consult your tax or legal adviser before making any tax-related investment decisions.
