Annuities Loss & Tax Deduction

When your annuity nest egg shrinks, your tax refund might increase.

When your annuity nest egg shrinks, your tax refund might increase.

Your annuity value took a dive and now you're looking for someone to help console you over your losses. While Uncle Sam might not be able to give you a hug, he may be willing to give you a tax break. If your annuity loss qualifies, you could find some relief when you file your income taxes.

Qualifying Plan Losses

If you have an annuity as a qualifying retirement plan such as a 401(k) or 403(b), you can claim a loss only if you take a lump-sum distribution and your basis is greater than the amount you receive. In addition, you must receive only cash and worthless securities. If you receive securities that aren't worthless at the time of the distribution, you can't claim a loss until you sell the securities. Then you can take a loss on the sale. Non-qualified plan annuity losses, such as commercial variable annuities, have the same requirements for claiming a loss. You must completely cash out your interest in the annuity and receive less than your basis. Commercial annuities contributions aren't usually tax-deductible, so it's more likely you will have a basis in the annuity.

Calculating the Deduction

The amount you can deduct equals your basis minus the amount you received from the lump-sum distribution. Your basis equals the amount of after-tax dollars you invested in the annuity. For example, if you buy an annuity for $50,000, watch it drop to $40,000 and cash out, you could have a loss of $10,000. However, if your 403(b) plan was funded entirely by pretax contributions, you have no basis in the plan and your plea for a tax break will fall on deaf ears.

Tax Documents

The IRS isn't very trusting of taxpayers, so when you take your lump sum distribution, your financial institution will send you and the IRS a Form 1099-R. This form reports the amount distributed to you in Box 1 and the amount you invested in Box 5. Also, the total distribution box in Box 2b should be checked to indicate you took a lump-sum distribution. You should receive the 1099-R in February after the year you took the distribution.

Claiming the Deduction

To claim the deduction, you have to itemize your deductions on Schedule A. For those of you taking the standard deduction, sorry, you're out of luck. In addition, the deduction is a miscellaneous one, subject to the 2 percent of adjusted gross income floor, meaning only the amount of the loss that exceeds 2 percent of your AGI can be deducted. For example, if your AGI is $75,000 and you suffered a loss of $4,000, you could deduct $2,500.

About the Author

Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."

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