How to Report a Roth IRA Surrender

Surrender charges can bite.

Surrender charges can bite.

A Roth individual retirement account allows you to contribute money on which you've already paid taxes. The money grows tax-free, and you can withdraw it without creating taxable income if you follow the rules. You can use your Roth IRA to buy an annuity. If you surrender a Roth annuity, your tax reporting depends on how the transaction goes down.

Annuities

An annuity is a contract in which you swap cash for a stream of monthly payments. You buy an annuity from an insurance company. You can get an annuity that will make payments for a set period, for your lifetime or longer. The payments may be for a fixed amount or can vary based on how much cash value you squirrel away before payments begin. If you buy a variable annuity, you normally invest your cash contributions in mutual funds and other investments. An annuity residing in an IRA is “qualified,” which means it must meet certain requirements of the Internal Revenue Service.

Roth IRA Annuity

IRA rules don’t allow you to transfer an annuity to a different owner. Your annuity provider can’t cause you to forfeit your interest in the annuity. You can contribute up to the annual limits of an IRA account. The annuity must allow you to make flexible contributions. You begin receiving payments on the “annuity date.” You can bail out of the annuity before this date, but the insurance company might slap you with a surrender charge.

Surrender Procedures

When you surrender an annuity, you get a cash payment from which the surrender charge has been subtracted. If the annuity provider pays the money directly into your Roth IRA, you have nothing to report. However, you might instead receive a check from the provider. You can roll this back into your Roth IRA within 60 days to avoid reporting a distribution. This also makes the surrender tax-free and penalty-free. Alternatively, you can keep the distribution, but you’ll have to report it. Surrender fees are not tax-deductible, and you don’t report them.

Roth Distribution

When you don’t roll over the cash you receive from surrendering a Roth-based annuity, you might owe taxes and penalties if you’re younger than 59 1/2. The tax is due on the amount that exceeds your contributions to the annuity. You’ll also have to a fork over 10 percent penalty on the same amount. Report the distribution on Part III of Form 8606. If you must pay a penalty, also file Form 5329. Include these amounts on Form 1040. The surrender charge might mean the money you receive from surrendering will be less than your contributions to the Roth annuity. In that case, you’ll owe no taxes or penalty payments.

 

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