Annuity - avoiding California state taxes

[HankNeva]

Hi...I'm considering taking a portion of my nestegg and putting it into an immediate fixed annuity to boost up the weak pension I'm getting here to match my basic expenses. This is not a question about the wisdom of investing in annuities as I know there are various opinons about this.

My question is whether this would be California based income, as annuity companies ask that you buy an annunity based on the state you reside in. As a long time resident of Japan I am increasingly finding I have to fend off the State of California tax people. I had to move my Fidelity accounts from my Japanese address to my mom's California address way back when they changed their policy on that. I have a bank account there, drivers license etc. But I have permanent residence here, legal residence here for US tax purposes, no intention to return and importantly - no California based income, so until now I have been able to put them off. I even got a reply a couple of years back saying they understand my situation, but letters still arrive at my moms asking me to pay which I keep replying to.

So I don't want to have to check that box - of having California based income as it might make me liable for California state taxes. Would an annuity be considered that?

If anyone knows about annuities and US state taxes, I would like to hear.

Thanks!

[TokyoWart]

I do not know the answer to your question but I would approach this as described below.
Annuities in the US are governed by State laws so there has to be some associated State for the annuity, however that should not mean that the State whose laws the annuity is following gets to tax it because that does not mean that the investments within the annuity are located in the State or the income is sourced from it.

The Franchise Tax Board says they do not tax California pensions or qualified annuities received by a non-resident:
“California does not impose tax on retirement income received by a nonresident after December 31, 1995. For this purpose, retirement income means any income from any of the following:
• A qualified plan described in IRC Section 401. • A qualified annuity plan described in IRC Section 403(a).
• A tax-sheltered annuity described in IRC Section 403(b).
…”
https://www.ftb.ca.gov/forms/2020/2020- ... cation.pdf

California has a Safe Harbor under which they do not tax people who leave California under an employment contract:

“Safe harbor is available for certain individuals leaving California under employment-related contracts. The safe harbor provides that an individual domiciled in California who is outside California under an employment-related contract for an uninterrupted period of at least 546 consecutive days will be considered a nonresident unless any of the following is met:
• The individual has intangible income exceeding $200,000 in any taxable year during which the employment-related contract is in effect.
• The principal purpose of the absence from California is to avoid personal income tax.”

https://www.ftb.ca.gov/forms/2020/2020- ... cation.pdf

[HankNeva]

Thanks, that's useful. The qualified - unqualified distinction is one that is important. Annunities seem to be made up of both depending on what money you use to buy the annuity. One is taxed differently I recall. I need to learn more about this.

[HankNeva]

I do think the Safe Harbor rule applies to me but there may be details about it that I don't know about and would work to my disadvantage. Anyway, I don't want to engage with the California Tax Board any more than necessary on this as they have the power to cause a lot of trouble even if wrong.

I spoke with Stan the Annuity Man...he's all over YouTube with good info and is a very good guy who I can recommend, and he advised against getting an annuity as I would have to elect a state of residence and it could be further ammunition for them.

[Tkydon]

Off the top of my head...

You don't mention the form of your Nest Egg, but...

Rather than an annuity, have you considered buying Dividend Paying Stocks, ETFs, or Mutual Funds?

If your Nest Egg is from a 401k or Taishokukin, then very low special taxation applies.

The dividends would be taxable in Japan.
If foreign dividends, the dividends would also be taxable in the country of the company paying the dividend.

If your total taxable income after any deductions/allowances is lower than Y3.3M, you can elect to use the Aggregate Taxation Method
(National 10% Marginal Tax, 0.21% Reconstruction, and 10% Residents' Taxes = Total 20.21%)

If your total taxable income after any deductions/allowances is lower than Y1.95M, you can elect to use the Aggregate Taxation Method
(National 5% Marginal Tax, 0.105% Reconstruction, and 10% Residents' Taxes = Total 15.105%) (after any deductions/allowances)

If your total taxable income after any deductions/allowances is greater than Y3.3M, you should elect to use the Separate Taxation Method
(National 15% Marginal Tax, 0.315% Reconstruction, and 5% Residents' Taxes = Total 20.315%)

(If the dividends span two bands, then the lower rate would apply for the lower portion, and the higher rate for the upper portion)

As a US Citizen, you may be subject to taxation in the US on US Dividend Income, or Foreign Withholding Taxes on other foreign sourced Dividend Income. You would need to confirm your situation, etc. with a qualified advisor.
If you do this through a US Broker, as a US Citizen they will not withhold US Taxes or Japanese Taxes, so you would have to file a Kakutei Shinkoku as well as your US Return.

If a non-resident non-US Citizen, one would be subject to US Withholding Tax on US Dividend Income of 10% as a resident of Japan under the US-Japan Tax Treaty. If through a US Broker, one should make sure you or they submit the W8-BEN form correctly.
They will withhold US Taxes but not Japanese Taxes, so one would have to file a Kakutei Shinkoku.
If through a Japan Broker or Interactive Brokers, they will submit the W8-BEN form correctly on your behalf, and if you instruct them to do so in a Tokutei Kouza, they will withhold US Taxes and Japanese Taxes, so you will not have to file, but if your income is below Y3.3M, it may still be in your best interest to do so.

If you do invest in US or other foreign Dividend Paying instruments, whether a US Citizen or not, you can claim any US Federal or Foreign Taxes paid on the income (but not State Taxes) as a Foreign Tax Credit against your Japanese Taxes above under the relevant Tax Treaty, for which you would receive a refund/credit, capping your total taxes at the rates listed above, and for which you would have to file. Other Allowances/Deductions such as Medical Costs, Furusato Nozei, etc. would also require you to file.

Some High US Dividend Paying Stocks...
https://www.nerdwallet.com/article/inve ... tocks#list
https://www.nerdwallet.com/article/inve ... -dividends

Depending on which broker you use, they will have a range of Income Yielding ETFs or Mutual Funds.

I don't know if that would allow you to avoid California State Taxes.

There may also be a difference between Dividend Taxes and Pension Taxes.

You should consult a qualified advisor.