IRS Taxation of Foreign Annuities

In today’s sophisticated financial market, there are many kinds of annuity products available: fixed annuity, variable annuity, immediate annuity, fixed-period annuity, and deferred annuity. There are even more sophisticated products such as private placement annuities in order to meet various clients' differing needs. The main benefit of buying an annuity contract is to get the tax-deferred benefit in addition to a guaranteed income stream.


Foreign Annuity Benefits


What is the real benefit of owning an annuity contract? In general, during the accumulation period, taxes on the growth are deferred — you will pay taxes only when you start the distribution from the annuity contract. However, these rules do not apply for certain foreign annuity contracts.


A friend of mine expatriated to Hong Kong in 2002. His wife bought annuity contracts in 2011 for herself, thinking these could supplement her retirement income when the time came. Because the income is intended for retirement, it is natural for her to not think of any tax consequences from this account until further on when she withdraws income from the account. After all, she hasn't received any income yet!


As it turns out, she bought a fixed annuity from HSBC bank and there is a taxable income from the fixed annuity contract. Unfortunately, she is required to do accounting on the account earnings and to report the same earnings on her tax forms. She also needs to fill out numerous forms to meet a series of other tax reporting requirements.


Taxing Offshore Annuities


The IRS's taxation of foreign annuities varies wildly depending on what type of annuity it is. It is true that annuity contracts in the US get tax-deferred growth. However, not all foreign annuities qualify the tax deferral growth. The IRS’s proposed section 1275 regulation denying tax deferral of the inside build-up of foreign annuities applies to fixed annuities, but not variable annuities.


US persons living abroad are especially vulnerable to these tax traps. Now my friend's wife not only has to report the income she earns on the contract every year, but she also has to fill out numerous informational tax forms. Always consult your qualified tax adviser before you buy any foreign investments.


If you need assistance with tax planning strategies, reporting, or resolving issues if you haven't reported, contact us. We can help.