Deferred annuity owners can access temporary, tax-free access to their account funds through an annuity loan. Generally, annuity loans can equal up to half the account balance. As long as the loan payments on time, the loan amount is not taxed.
Loans and interest are paid back to the annuity account. If the owner stops making loan payments or default settings, the loan is treated as a distribution. In the United States, annuity distributions are taxed on income. A penalty charge is also charged if the borrower is under age 59 1/2.
In general, insurance companies provide annuities. These insurance companies set interest rates and terms for annuity loans. Some companies charge the loan service fees in addition to interest.
Annuity loans are preferred over withdrawals to access annuity funds. Loans can save the owner money on taxes. Payments are immediately subject to income tax and penalty tax, if applicable.
Borrowers usually have up to five years to repay an annuity loan. Some insurance companies extend the repayment period for loans used to purchase a primary residence. The extended maturity is usually no more than 20 years.
These loans also have some drawbacks. If one is not paid back in time, it is treated as a distribution. The borrower is obliged to immediately repay the loan, interest due, loan fees, plus any taxes due. If the owner is unable to repay the loan, interest will continue to accrue on the outstanding balance of the loan.
Annuities are designed to build tax deferred earnings. These income will then be paid in installments to provide retirement income. Loans will slow down annuity is the earning capacity until funds are paid out. Any outstanding balance on the loan does not earn interest.
When a loan against an annuity is never repaid, the owner will defeat the purpose of the annuity. Any funds that are not returned to annuity will no longer contribute to tax deferred account growth. This reduces the resources needed to secure income at retirement age.
Unique annuity loans also prevent the owner from transferring or rolling past, annuity to another insurer without penalty. In general, the borrower must hold annuity with the current insurance company until the loan is repaid. Some insurance companies will allow for transfer. In this case, any outstanding balance on the loan is treated as a distribution and is taxed accordingly.
If annuity is part of the borrower’s company pension scheme, annuity loans have additional risks. Normally, if the borrower leaves or terminates the employer, the outstanding balance of the loan must be repaid immediately. If the employee is unable to repay the loan, the outstanding balance of the loan becomes a distribution. Income tax, and possibly penalty tax, will apply.