Tennessee Retirement Taxes: What Annuity Holders Need to Know

Tennessee Retirement Taxes: What Annuity Holders Need to Know

Wondering how Tennessee taxes affect your annuity income? This plain-English guide covers what retirees in Nashville, Knoxville, and Memphis need to know.

Full written article: Tennessee Retirement Taxes: What Annuity Holders Need to Know

Tennessee Annuity Rates

Transcript

SPEAKER_01 0:03

Welcome to the Tennessee Annuity Show. I'm Jessica.

SPEAKER_00 0:06

And I'm Caleb. We break down complex annuity products in plain English, fixed annuities, indexed annuities, income annuities, all of it.

SPEAKER_01 0:13

We cover the products, the fine print, and the questions you should ask before you sign anything.

SPEAKER_00 0:18

Quick note before we start. This show is for general information only and is not financial, tax, or legal advice. Annuity guarantees depend on the issuing insurance company's ability to pay claims. Talk with a licensed professional before making decisions about your retirement income.

SPEAKER_01 0:33

All right, let's get into today's episode. So I had a conversation with my aunt over the holidays. She's 68, just moved from Ohio to Nashville. Um, and she kept saying, Well, uh, Jessica, I feel like I'm missing something because my tax bill just looks so much smaller than it used to. And uh, I kept thinking, yeah, there's actually a real story there.

SPEAKER_00 0:56

She's not missing anything. She's just in a state that genuinely doesn't tax most retirement income. Tennessee is one of those places where the tax picture is almost surprisingly clean once you understand what's actually on the books. Or more accurately, what's been taken off the books.

SPEAKER_01 1:13

Right. And I think that's the thing people don't realize until they're already living there. So let's actually walk through it because I want people to understand the mechanics. Not just here, Tennessee is tax-friendly and move on.

SPEAKER_00 1:26

Totally agree. So the big one, Tennessee does not have a broad state income tax. No tax on wages, no tax on retirement income, no tax on annuity payments. Uh, and there used to be something called the Hall income tax, which caught a lot of people off guard because it applied to interest and dividend income.

SPEAKER_01 1:43

Wait, so people who had dividend-paying accounts were getting taxed, even though Tennessee was supposedly low tax?

SPEAKER_00 1:50

Exactly. And it tripped people up for years. But that was fully repealed as of January 1st, 2021. So it's gone. Done. That means if you're a Tennessee retiree uh drawing income from an annuity contract, a pension, Social Security, the state takes nothing from any of that.

SPEAKER_01 2:10

Okay, so that's a big deal, but I want to make sure we're being precise here because the federal piece is still very much alive, right?

SPEAKER_00 2:19

Oh, absolutely. The IRS doesn't care what state you live in. Federal taxes on annuity income are still very real. And the way they work depends a lot on how you funded the contract in the first place.

SPEAKER_01 2:29

Walk me through that because I think this is where people get confused. They hear annuity income and assume it's all taxed the same way.

SPEAKER_00 2:37

So there are basically two buckets. If you funded the annuity with after tax dollars, meaning you already paid income tax on that money before it went into the contract, then only the earnings portion of each payment is taxable federally. The part that's just your original premium coming back to you, not taxed again.

SPEAKER_01 2:54

That makes sense. You already paid tax on that money.

SPEAKER_00 2:57

Right. But if you funded it with pre-tax dollars, say you rolled over a traditional IRA into an annuity, then the full payment is generally taxable as ordinary income at the federal level, because none of that money has ever been taxed.

SPEAKER_01 3:09

Okay, and there's a term for how they calculate the split in that first scenario, isn't there? I've heard it, but I always have to think for a second.

SPEAKER_00 3:17

The exclusion ratio.

SPEAKER_01 3:32

Yeah, and I want to flag that for listeners. We're not tax advisors, we're not giving anyone personalized tax advice here. This is the framework. Your actual numbers need to come from a professional who knows your specific situation.

SPEAKER_00 3:47

Couldn't agree more. The framework matters though, uh, because if you don't understand the exclusion ratio concept going in, you might be surprised by your first tax bill after you start taking payments.

SPEAKER_01 3:56

So let me bring this back to something practical. When people are shopping for annuity rates in Tennessee, and that's a real thing people do, they're comparing rates across carriers. How does the tax environment actually affect what a rate is worth to them?

SPEAKER_00 4:12

This is actually one of my favorite things to explain, because the quoted rate is only part of the story. Picture two retirees. Same age, same contract, same rate. One lives in Tennessee, one lives in a state with a 5% income tax on retirement distributions. The Tennessee retiree keeps more of every single payment. The effective value of that rate is higher here.

SPEAKER_01 4:35

So it's not just about finding the highest rate on a comparison sheet. It's about what actually lands in your checking account.

SPEAKER_00 4:42

Exactly. And that's why when people are looking at uh Tennessee annuity rates specifically, the state tax context is part of the math. Um, a rate that looks modest on paper might actually outperform a higher rate in a higher tax state once you run the net income numbers.

SPEAKER_01 4:56

Okay, but I want to push back a little because I think there's a risk of people hearing that and thinking, great, I don't need to shop around as hard because Tennessee already gives me a boost. That's not right either.

SPEAKER_00 5:09

No, that's a fair pushback. Rates still vary, sometimes significantly, oh, by carrier, by contract type, by term length, by your age. You absolutely still need to compare. The Tennessee tax advantage amplifies whatever rate you get. It doesn't replace the work of finding a competitive rate in the first place.

SPEAKER_01 5:26

Good. Okay, so let's talk about the types of contracts people are actually using, because I get questions about this a lot, especially from people who are like, I just want something simple. I don't want to think about the market.

SPEAKER_00 5:40

So the most common starting point for that kind of person is usually um fixed annuity or a myja multi-year guaranteed annuity. The MYGI is basically a fixed annuity that locks in a specific rate for a set term. Three years, five years, seven years? Um it depends on the contract.

SPEAKER_01 6:00

And the rate doesn't move during that term?

SPEAKER_00 6:02

That's the contractual structure, yes. Um it's stated in the contract. Now I want to be careful here. I'm not saying that makes it a no downside product because there are surrender charges if you need to get out early, and there are other trade-offs. But the rate itself is defined in the contract for that term.

SPEAKER_01 6:18

In the uh surrender charges. That's the part people always forget to ask about until it's too late.

SPEAKER_00 6:24

Always. And the surrender period can be long. Some contracts have surrender schedules that run seven, eight, even ten years. If you need liquidity before that window closes, you're looking at a penalty. So the question isn't just what's the rate, it's can I actually leave this money alone for this long?

SPEAKER_01 6:44

I had uh I had a listener, I'll keep it vague, who bought a seven-year MyGA and then had a family situation come up in year three. Uh and the surrender charge at that point was still pretty steep. She hadn't really internalized what that schedule looked like when she signed.

SPEAKER_00 7:02

That's such a common story. And it's not that the product was wrong for her necessarily. It's that the conversation about liquidity needs didn't happen thoroughly enough before the purchase.

SPEAKER_01 7:14

Right. Okay, so what about people who are already retired and need income now, not accumulation, income.

SPEAKER_00 7:20

That's where SPIA comes in. Single premium immediate annuity, you hand over a lump sum, and payments start almost right away. Usually within a month or so, it's a way to convert a chunk of savings into a predictable income stream.

SPEAKER_01 7:32

And the trade-off there is that you're giving up control of that principle, right? Like once you hand it over, it's gone.

SPEAKER_00 7:39

In most structures, yes, you're essentially exchanging a lump sum for a stream of payments. There are variations. Some contracts have period certain options, some have return of premium features. But the basic SPIA structure is you give up the lump sum. You get the income. That's the deal.

SPEAKER_01 7:58

Which for some people is exactly what they want. They don't want to manage it, they don't want to worry about it, they just want the check.

SPEAKER_00 8:05

And in Tennessee, where that income isn't being taxed at the state level, that check goes a little further. It's not a huge number in isolation, but over a 20-year retirement, it adds up.

SPEAKER_01 8:15

Let's talk about the annuity versus CD question, because I feel like this comes up constantly, especially with older retirees who are used to just putting money in a CD at their bank.

SPEAKER_00 8:25

It's uh probably the most common comparison I hear. And they're not crazy to compare them. Both offer a defined rate for a set period. Both feel familiar, but they are fundamentally different products, and the tax treatment alone is a meaningful distinction.

SPEAKER_01 8:39

How so?

SPEAKER_00 8:39

CD interest is generally taxable in the year it's credited. So even if you're not uh touching the money, you're getting a tax bill on the growth every year. With an annuity, the earnings grow tax deferred. You don't owe federal income tax on the growth until you actually take a distribution.

SPEAKER_01 8:54

So you're not getting a surprise tax bill every April just because the annuity earned interest that year.

SPEAKER_00 9:00

Exactly. And that compounding effect of deferral over a multi-year term can actually be pretty significant, even if the stated rates are similar.

SPEAKER_01 9:07

Okay, but CDs have FDIC insurance. That's a real thing. Annuities don't have that.

SPEAKER_00 9:13

Right. And I'm glad you brought that up because it's an important distinction. Annuities are backed by the claims paying ability of the issuing insurance company, not a federal agency. Tennessee does have the Life and Health Insurance Guarantee Association, which provides a layer of protection within statutory limits, but it's not the same as FDIC coverage.

SPEAKER_01 9:30

So that's why financial strength ratings matter when you're picking a carrier.

SPEAKER_00 9:34

That's exactly why. It's one of the questions you should be asking before you sign anything. What is the carrier's financial strength rating? AM, best, Moody's S P. Those ratings exist for a reason.

SPEAKER_01 9:47

And this is not a case of one product being better than the other across the board. It depends on what you need.

SPEAKER_00 9:53

Completely. If you need that money in 18 months and you want FDIC protection, a CD might make more sense. If you're parking money for five or seven years and you want tax-deferred growth, uh a MOIGA might be worth a serious look. But that's a conversation to have with a licensed agent who knows your full picture.

SPEAKER_01 10:12

Who let me bring up something else in the article that I think people gloss over, the social security piece. Tennessee doesn't tax social security either, right?

SPEAKER_00 10:22

Correct. No state tax on social security benefits. And when you layer that on top of no state tax on annuity income, no state tax on pension income, you start to see why retirees who are drawing from multiple sources find Tennessee pretty appealing.

SPEAKER_01 10:44

And she kept saying, Why did nobody tell me about this state? Like she felt like she'd been overpaying for years.

SPEAKER_00 10:51

And she probably was relative to what she's paying now. That's a real difference in take home income every single month.

SPEAKER_01 10:57

There's also the property tax relief programs, which I think are worth at least a mention, because a lot of retirees are homeowners and property taxes are a real line item.

SPEAKER_00 11:08

Yeah. Tennessee has programs for qualifying elderly and disabled homeowners. The details vary by county. Nashville, Knoxville, Memphis all have their own trustee offices that administer this. So you'd want to check locally for current eligibility. But it's worth knowing those programs exist.

SPEAKER_01 11:25

The one caveat I always want to throw in is the sales tax situation. Tennessee's sales tax is on the higher side, so it's not like everything is cheap. You're going to feel it at the register.

SPEAKER_00 11:38

That's a fair point. The income tax picture is excellent. The sales tax picture is less rosy. So when you're building a retirement budget, you can't just look at one number and declare victory. You have to look at the whole thing.

SPEAKER_01 11:49

Okay, so let's bring this home a little. If someone is sitting in Tennessee right now or thinking about moving there, and they're trying to figure out whether an annuity makes sense for their retirement income plan, what are the questions they should actually be walking into that conversation with?

SPEAKER_00 12:05

First one is the contractual rate and how long it's in effect. Not a projected rate, not a hypothetical what does the contract actually say and for what term.

SPEAKER_01 12:13

And then the surrender schedule.

SPEAKER_00 12:15

Right away. What are the surrender charges? What does the schedule look like year by year? And what are your liquidity options if something comes up? Some contracts have free withdrawal provisions, usually around 10% per year, but you need to know the specifics.

SPEAKER_01 12:29

Then the income options, right? Because not everyone is buying for accumulation. Some people want to know exactly how they'll eventually turn this into income.

SPEAKER_00 12:39

Yes. And that's where the federal tax treatment of those income payments becomes really important to understand before you commit. How much of each payment is taxable? What does the exclusion ratio look like for your specific contract? These aren't questions to answer after the fact.

SPEAKER_01 12:54

And the carrier's financial strength rating. You mentioned that earlier, but it bears repeating.

SPEAKER_00 12:59

It does. Because you might be in a contract for 10, 15, 20 years. The company needs to be around and financially healthy for the life of that contract. Ratings aren't a perfect crystal ball, but they're a meaningful data point.

SPEAKER_01 13:12

The last one I'd add is the big picture question. How does this fit into everything else? Because an annuity in isolation is just a product. An annuity as part of a retirement income plan is a tool.

SPEAKER_00 13:25

That's well put. And that's really the work of a good licensed agent, not just presenting you with a rate sheet, but helping you figure out how a contract fits alongside Social Security. A pension, if you have one, other savings. The Tennessee tax environment makes that conversation a little more favorable, but the planning work is still the planning work.

SPEAKER_01 13:42

I think the thing I keep coming back to is that the tax advantage is real, but it's not a substitute for doing the homework. Like you can't just say Tennessee doesn't tax my annuity income, therefore I'm all set.

SPEAKER_00 13:56

No, because you still have federal taxes to deal with, you still have to pick the right contract type for your situation, you still have to understand the surrender schedule, you still have to evaluate the carrier. The state tax piece is genuinely favorable. It just doesn't do all the work for you.

SPEAKER_01 14:13

And the federal piece can still be significant depending on how you funded the contract. If you rolled a big traditional IRA into an annuity, those payments are ordinary income. It's at the federal level. That's not nothing.

SPEAKER_00 14:27

Right. And that's exactly why a tax professional needs to be in this conversation, not just an insurance agent. The agent can tell you about the contract. The tax professional can tell you about the implications of how you funded it and how you'll be taking distributions.

SPEAKER_01 14:42

Um, so the team approach. Licensed agent, tax professional, maybe a financial planner, depending on how complex the picture is.

SPEAKER_00 14:50

That's the move. Especially for someone with a meaningful sum to deploy, say, a couple both in their mid-sixties with $200,000 they're trying to figure out what to do with. That's not a one conversation, one product decision.

SPEAKER_01 15:02

And Tennessee's tax structure means that when they do land on the right plan, more of it stays with them, which is kind of the whole point of retirement planning.

SPEAKER_00 15:12

That's the bottom line. The state isn't going to take a cut of your annuity income, your social security, your pension. The federal government still will, to varying degrees depending on your situation. But the state piece, that's genuinely off the table in Tennessee, and that matters.

SPEAKER_01 15:27

I'm gonna tell my aunt she made a good call moving to Nashville, even if she complains about the sales tax every time she goes to the grocery store.

SPEAKER_00 15:34

Tell her to look at her net monthly income from all those sources, and then look at what she was paying in Ohio. I think she'll feel better about the grocery bill.

SPEAKER_01 15:46

That's it for today's Tennessee Annuity Show.

SPEAKER_00 15:48

If you have questions about your specific situation, talk to a licensed advisor.

SPEAKER_01 15:52

Visit Tennessee AnnuityRates.com for show notes or to get matched to an advisor.

SPEAKER_00 15:57

We'll see you next time.