What Is a State Premium Tax?

State premium taxes can be high, so if you’re considering buying an annuity, be aware of how the premium tax might affect the value of your annuity.

With the exception of Illinois and Michigan, the states generally don’t tax insurance companies the same way they tax other businesses. The states tax other businesses on their corporate income. Insurance companies are taxed on the value of the premiums they write in a state.

It is important to understand that each state is free to tax every aspect of an insurance company’s premiums. That includes premiums they receive from the sale of annuities. The reason you need to be careful is that those taxes are almost always passed on to you when you buy an annuity.

You will pay state premium taxes at one of two points in time.

If you buy an immediate annuity, you will pay the premium tax up front. The tax won’t be added to your out-of-pocket premium payment. Instead, it will be deducted from the initial value of the annuity contract.

When someone buys a deferred annuity, the premium tax is collected during the annuitization, or payout, phase. The premium tax will be deducted from the first payment.

Nearly all U.S. states and territories charge insurance companies a premium tax. But not all of them levy the tax on annuities. There are only a handful of states that charge a premium tax on annuities.

Source: National Association of Insurance Commissioners

Importantly, many of the states that do charge a premium tax on annuities waive it when they are purchased inside a qualified plan, such as an IRA, 401(k) or other type of employer-sponsored retirement plan.

For many people considering an annuity, avoiding the premium tax is simple. Most states don’t charge it on annuities. For consumers living in one of the seven states that charge the tax, there are a couple of planning considerations available.

Those already preparing to move to a state that doesn’t charge the tax should hold off buying an annuity until after the move is completed.

Those who have a residence in two different states — where one is a high-tax state and the other is a low- or no-tax state — should seek the advice of their financial and legal advisors to determine if purchasing an annuity when living in the home in the low-tax state is possible.

Taxation is not the only aspect of annuities that the states regulate. Rates, features, and benefits can all vary widely based on the rules and individual tax codes of each state.

The individual states determine which features of a product they will approve for sale. Some states regulate how and to whom an annuity may be sold. Others regulate the types of riders available for purchase.

States may also treat the various types of annuities differently. They may regulate immediate annuities differently from the way they govern deferred annuities. All annuities are insurance products. But deferred annuities are also regarded by most states as securities. It is also important to understand that under federal law variable annuities are categorized as securities, regulated by the U.S. Securities and Exchange Commission.

Regardless of the state in which your annuity is issued, it makes sense to consult with a financial advisor to determine which type of annuity is appropriate for you.