If I put income from a home sale into an annuity, will I still be forced to pay income taxes?
I just sold my house. If I put the entire amount in an annuity, will I still have to pay income taxes on that money?
If you sell your principal residence in which you have lived for at least two of the last five years and the gain is less than $250,000 (Single, $500,000 for a couple who file taxes jointly), you will qualify for a tax exclusion, regardless of what you do with the net proceeds. If you sell a property in which you have not lived the requisite amount of time, you will owe capital gains tax on any profit.
Buying an annuity or any other investment with the proceeds of a prior sale creates a new tax basis in the new investment. Annuities generally grow tax deferred as long as the income remains in the annuity contract. Ordinary income tax is due when the owner of the annuity makes a withdrawal or when an annuity is surrendered. The tax is on any positive change in value since the initial purchase. The principal (the tax basis) is not taxed again.
A multi-pronged question:
First, you don't really have income taxes from the sale of the home unless you owned it for a short time. You may have to pay capital gains taxes on the gains from the home sale (if you lived there as a primary residence for 2 out of the last 5 years you also get a $250,000 exemption on those gains), but if you lived there for less than a year you will have to pay short term capital gains taxes at income tax levels.
If you then invest the money in an annuity your income taxes on the gains you earn from the annuity are merely deferred until you withdraw them. So if you invest $300,000 from the home sale in the annuity which then grows to $400,000, you ahve a $100,000 gain. Withdrawals from annuities are "last in, first out", meaning your most recent additions (I.e. taxable gains) come out first, so your first $100,000 withdrawn are all income taxable. If there is no gain and you are merely withdrawing principle then there are no income taxes. You may also choose to "annuitize" the policy which will lead to some of the withdrawals being income taxable, and some portion as untaxable principle.
Hope this is helpful.
If it is your primary residence and you have lived there for any 2 of the last 5 years, then you do not have to pay tax on the first $250k of capital gains. If you are married, then you both get $250k for a total of $500k. So there may not be any or much less tax than you think. But if you do have to pay the tax, and annuity will not help.
I am not a big fan of annuities anyway as they are expensive and clumsy investment vehicles for various reasons I won't go into. Suffice it to say that even the "indexed" annuities that are all the rage are designed to pay around 3% to 4% annualized. Whether it is monthly averaging, caps, etc.. you will not make high single digit returns. So I would think long and hard before investing in an annuity. There are a few good reasons for an annuity, I just believe they are way overused.
Hope this helps and best of luck, Dan Stewart CFA®
For details on income tax exclusion for a home sale, you can learn more here. Remember that an annuity can have very high upfront fees, capped returns, stiff penalites, and loss of principal once the payout phase is initiated. You may want to consider a moderate ETF portfolio instead.
The IRS couldn't care less where you put the money from the sale of a house. It doesn't affect your taxes on that house which depend entirely upon the gains minus improvements, and whether or not you lived in the house for at least 2 out of the last 5 years. If you did live there for at least 2 out of the last 5 years then you can exclude from your income 250 thousand of your net capital gains (capital gains minus home improvements) or 500 thousand if you are married. Otherwise you have to pay capital gains taxes on the entire increase minus improvements.
Putting money into an annuity is almost always a bad idea, but that is a topic for another question. Annuities have high fees and all kinds of penalties for withdrawal before age 59-1/2, and usually your net gains will be low. In addition, you might be locked for years into a low-yielding annuity. Interest rates aren't going to remain low forever.