How does the federal income tax treatment of annuities compare with the income tax treatment of life insurance?
In general, the tax treatment accorded life insurance is more favorable. For example, life insurance death proceeds are generally received income tax free by the beneficiary; in contrast, only the cost basis of an annuity contract is received income tax free at the annuitant’s death. Further, policy loans against the cash value of a life insurance contract do not trigger taxable income to the policy owner, whereas a loan against the cash value of an annuity contract may create taxable income to the annuitant. Similar tax treatment applies to the “interest build-up” portions of life insurance and annuity cash values since current income taxation is avoided under both types of contracts. Because federal income taxation is a complex subject and because other taxes may apply (e.g., federal estate taxes), your tax adviser should be consulted with regard to all forms of taxation of annuity and life insurance products.
