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Ha11ck asks:

<<My wife just inherited $80k through two annuities (they were 20 year annuities and were set-up about 10 years ago). We elected to have a lump-sum distribution (the interest appeared to be only about 4% a year), filled out some form about tax witholdings, and they withheld taxes based on our normal filing status and exemptions. My question is this - what taxes will we owe on this annuity? 1) the whole 80k? at what rate? capital gains rate - 20%, or will it all be considered income which will be taxed at least 28% and likely higher based on our income, or 2) only the amount that was made in profit on the 80k, assume 25-50% (my guess), or on 20-40K of it, or 3) none of it, since it was an inheritance which is tax free up to 500k (or is that for estate taxes). To complicate the situation, her mom contributed to this teacher's association annuity which may have let her (mom) invest her money in this annuity tax-free at the time of investment. I really believe we probably owe on the whole 80K, which makes me kindof sick now, because it will likely be taxed at the income rate... >>

From your description, it's hard to tell whether this was an ordinary tax deferred annuity purchased with after-tax dollars or one purchased with pre-tax dollars as part of a 403b plan. You will owe income taxes on anything that wasn't previously taxed. That means all earnings, and potentially all contributions as well. It's possible you must declare the full $80K as income and be taxed thereon at ordinary rates. I suggest you contact the insurance company to determine what portion of that payment will be taxable to you.

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