How Annuities Are Taxed — What You Don’t Know Can Cost You
Are you thinking of buying an annuity? Before you do, it’s important to understand how it will be taxed when the time comes to take income or make withdrawals. This article gives you a brief overview of key annuity tax rules, helpful tips, and links to more in-depth guides.
How Is Annuity Income Taxed?
Annuities are taxed as ordinary income. This means that there are no capital gains taxes to consider. Instead, the amount of your annuity payment that is taxable is included in your taxes as ordinary income and taxed accordingly.
What is the Annuity’s Tax Status?
If you’re looking into annuities, you’ve probably come across the words “qualified” and “non-qualified”. But what do these terms mean?
Simply put:
- Qualified: the money used to buy the annuity was tax-advantaged, such as funds from an IRA or 401(k)
- Non-qualified: funds were after-tax savings with no special tax advantages, though annuities can offer tax advantages to this type of funding
This is important because the type of money you use to buy your annuity, qualified or non-qualified, determines how it will be taxed.
Don’t worry, we have a great article if you want to know more about how the tax qualification of your annuity affects taxation.
Are Different Types of Annuities Taxed Differently?
Yes, the taxation of your annuity not only depends on the type of funds you used to buy the annuity, but also the type of annuity that you buy.
For instance, “income annuities” are taxed differently than “tax deferred annuities”. Income annuities, which include Immediate Annuities and Deferred Income Annuities, irrevocably convert your money into a guaranteed income stream. On the other hand, tax-deferred annuities grow your money, sometimes with options like income riders that also guarantee income.
However, the tax treatment of these annuities can vary significantly and have a major impact on your overall taxes. We have two related guides that can help you:
- A Guide To The Taxation of Income Annuities (Immediate and Deferred Income Annuities)
- A Guide To The Taxation of Deferred Annuities (Fixed Index and Multi-Year Guarantee Annuities)
On top of that, there is a special class of annuities called Qualified Longevity Annuity Contracts that have very specific tax rules that can help you reduce your required minimum distributions.
Who Is Responsible For Paying the Taxes on an Annuity?
Generally speaking, the owner is responsible for paying taxes on an annuity.
While this may seem straightforward, most annuities have an owner, annuitant, payee, and maybe even beneficiaries. And these roles can all belong to different people.
To learn more about these different designations in an annuity contract, read this article about the ownership of annuities.
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What if I Have Multiple Annuities, How Are They Taxed?
This is a great question—and one we get often. If you are considering a strategy such as an annuity ladder, you should be aware of how annuity Aggregation Rules may impact the taxable amount of your withdrawals. To learn more, please read our article about Annuity Aggregation Rules.
Are There Any Tax Penalties With Annuities?
There are typically no tax penalties for owning an annuity, except under very specific circumstances. Let’s break down a few of these circumstances so you do not unwittingly incur any penalties.
Early Withdrawal Penalties
If you have a tax-deferred annuity like a Multi-Year Guarantee Annuity or a Fixed Index Annuity, and you take your money out before reaching age 59½, you may be charged a 10% penalty on your earnings in addition to regular taxes.
The same goes for taking money out of your Traditional IRA or 401k before 59½. You may receive a 10% penalty in addition to regular taxes.
The good news is that you can sometimes avoid these penalties by using a Substantially Equal Periodic Payments (SEPP) strategy.
Last-In, First-Out (LIFO) vs. Exclusion Ratios
While this isn’t technically a tax penalty, the difference in how income annuities are taxed (exclusion ratio) and deferred annuities are taxed (LIFO) can make a big difference in your tax bill.
Essentially, deferred annuities withdrawals are paid-out interest first (LIFO), frontloading your taxable burden. Income annuities are taxed equally over the duration of the annuity, effectively distributing your tax burden across the life of the annuity.
This means that deferred annuities can dramatically increase your taxable income when you start making withdrawals from them. However, there are strategies to spread out your taxable income which utilize the favorable tax treatment of income annuities.
Are Annuities Good or Bad For Taxes?
Annuities can play a valuable role in your tax-planning strategy. However, there is no blanket “good or bad” verdict on how annuities will impact your taxes. Instead, it’s best to familiarize yourself with the rules around annuities and taxes, so you can discuss these rules with your tax advisor.
If you need any help understanding how annuities are taxed, please call our annuity experts at (866) 866-1999. We’ll go through your questions with you and help you understand the details of annuities. We’re here to help you.
How are annuities taxed?
The taxable portion of an annuity withdrawal or disbursement is taxed as ordinary income.
Can I combine IRA and personal savings into one annuity (qualified and non-qualified)?
No, you cannot mix qualified and non-qualified funds. Your annuity must be funded with one tax qualification. However, you can often combine multiple funding sources (with the same tax status) into one annuity. For example, you can use multiple IRAs to fund a single annuity.
Do annuities pay out interest or principal first?
Most cash-value annuities (e.g. Multi-Year Guarantee Annuities, Fixed Index Annuities) pay out interest first, called Last-In First-Out (LIFO). Immediate Annuities and Deferred Income Annuities, which “annuitize” your funds, distribute your taxable portion throughout the payout period.
Can I take money out of my annuity or retirement account before 59½?
Generally speaking, you will get a 10% penalty for removing funds from a tax-deferred account prior to 59½ in addition to regular taxes. However, you can sometimes use a SEPP (Substantially Equal Periodic Payments) plan to avoid these penalties. An Immediate Annuity can be one way to set up a SEPP. SEPP rules are complicated though, so work with a tax professional to ensure this will work for you.
Who is responsible for the taxes on an annuity?
The owner of the annuity is responsible for the taxes due on an annuity. While the owner is often also the annuitant and payee, this is not always the case. So it is possible that the person getting paid is not responsible for paying taxes on the payments.
Disclaimer: We are not tax advisors. This article is for informational purposes only and does not constitute tax advice. Please consult a certified tax professional regarding annuities and taxation.
References:
- “Publication 590-B (2024), Distributions from Individual Retirement Arrangements (IRAs)” Internal Revenue Service. Retrieved October 2, 2025.
- “Publication 575 (2024), Pension and Annuity Income” Internal Revenue Service. Retrieved October 2, 2025.
- “How Are Annuities Taxed?” Western & Southern. Retrieved October 2, 2025.
