Annuities can be tax time bombs

The tax deferral annuities offer is one of their big selling points. But people who buy them often don't understand that these investments carry negative tax consequences too. Today's column is about a couple (Keith and Dolores Cutler, shown here) who learned about one of those consequences the hard way. Here are some things you need to know about annuities and taxes:

Annuities and taxes

- Taxes are deferred as long as the money stays in the annuity.

- When an annuity is purchased outside a retirement plan (with after-tax dollars), withdrawals are partly taxable/ partly tax-free return of principal.

- Withdrawals are taxed as ordinary income, not capital gains, even when they are invested in stocks.

- Taxes may continue to be deferred in a direct annuity-to-annuity transfer between companies, known as a 1035 exchange.

- An heir who inherits your annuity is taxed the same as you would be. There is no step-up in basis at your death.

[Times photo]