Your Guide To The Taxation of Immediate And Deferred Income Annuities

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Written by Ariel Stern Updated October 9, 2025

Understanding how an income annuity (a category which includes Immediate Annuities and Deferred Income Annuities) is taxed is crucial to your annuity strategy. How you will be taxed can have a big impact on your finances.

You probably know that taxable income affects not only what you’re going to take home from your annuity, but could also affect your eligibility for certain programs available to retirees like Social Security and Medicare.

So it’s worth it for you to take a few minutes to understand how your annuity will be taxed.

In this article, we will address:

What Is an Income Annuity?

Let’s first define exactly what an income annuity is so that we are perfectly clear on what these tax rules apply to. An income annuity is an annuity where you pay a single, lump sum premium to the insurance company. In return, the insurer promises to make regular payments to you, often for the rest of your life.

Income annuities operate by performing a very specific action with your money that impacts how it is taxed: annuitization. Annuitization effectively irrevocably converts your annuity into a guaranteed income stream. As a result of this annuitization, income annuities also get some special tax treatment.

We’ll get into this special tax treatment, and how it can potentially help you, but first let’s explore how it is applied.

How Are Earnings From an Income Annuity Taxed?

Earnings from your income annuity are taxed as ordinary income. This means that any taxable portion you receive from your income annuity is included in your total taxable income for the year and taxed at your effective tax rate.

How Does the Account Type Used To Buy the Annuity Impact Taxes?

Whether your money is qualified (e.g. pre-tax IRA or 401(k) money) or non-qualified (e.g. regular post-tax savings) has a big impact on how your income annuity is taxed. Here’s a quick comparison of how your annuity’s tax qualification will impact its taxation:

  • Traditional IRA (Qualified) — Income is fully taxable
  • Roth IRA (Qualified) — Income is never taxable
  • Non-Qualified — Income is partially taxable (interest is taxed, but not return of premium)

If your money is in a qualified account, its taxation depends on whether it is a Traditional IRA or Roth IRA. Traditional IRAs are pre-tax, so your income is fully taxable. Roth IRAs have already been taxed, and their benefit is that the earnings are tax-free, so the income from Roths is never taxable.

While non-qualified annuities are a little more complicated, you can use their taxation to your advantage. But first let’s explore how non-qualified annuities are taxed.

How are Non-Qualified Funds Taxed in an Income Annuity?

For both Immediate Annuities and Deferred Income Annuities, your income from a non-qualified annuity is taxed over the lifetime of that annuity. The insurer will issue an “exclusion ratio” or “taxable portion” in your annuity quotes showing you how much of each payment is taxable.

In practice, this means that a portion of each payment to you is taxable as income, and the rest is non-taxable. The taxable part is earnings, and the non-taxable part is a return of premium. This is true until you have received your original premium back in full, which occurs at the end of your life expectancy in IRS tables.

Once you have received your original premium back in full, the entirety of each payment becomes taxable. This is because the part you already paid tax on (your premium) has been returned to you.

While this may seem like a negative, this means that the income from your annuity is now all earnings, and that you’ve outlived your life expectancy.

How Is the Taxable Portion of a Non-Qualified Income Annuity Calculated?

First, you do not need to calculate what the taxable portion of your income annuity will be. This calculation is done by the insurance company and included in your annuity quote. It is a standard calculation, which you can find guidance on directly from the IRS.

We will break it down simply for you, however, so you at least understand how this calculation is being performed.

When you buy an annuity, there is a distribution period (called a “multiple” by the IRS) associated with that annuity. Essentially, this is how long you are expected to get payments from your annuity. If you buy a “period certain” annuity, the multiple is the number of years it will pay you. If you buy a lifetime annuity, this multiple is your life expectancy according to IRS tables.

You take this distribution period and multiply it by your annuity income to calculate the total amount you are expected to receive from your annuity. Then you take your original premium (which has already been taxed) and divide it by this number. This gives you your exclusion ratio, or the amount of each payment that is excluded from taxation.

Here is an example of how to calculate an exclusion ratio:

  1. You buy an Immediate Annuity with a $100,000 premium
  2. Your life expectancy at purchase is 18 years
  3. Your annual annuity income is $8,000
  4. Total expected payments: $8,000 × 18 = $144,000
  5. Exclusion ratio: $100,000 ÷ $144,000 = 69.4%
  6. Non-taxable portion: 69.4% × $8,000 = $5,552 (return of premium)
  7. Taxable portion: $8,000 − $5,552 = $2,448 (earnings)

Some insurers list your exclusion ratio on your quotes. If they do this, you will need to calculate your taxable income from this ratio (or call us, we can help with this). Other insurers will just show you how much is taxable or tax-free each month on your quotes.

Do Immediate and Deferred Income Annuities Have Different Tax Rules?

No, there is a standard methodology for the taxation of annuities issued by the IRS that all insurers should follow. However, the way in which Immediate Annuities are taxed does vary slightly from how Deferred Income Annuities are taxed.

Immediate Annuities

Since your Immediate Annuity begins making payments within a year of purchase, your distribution period is (generally speaking) either the rest of your life or the period certain. What does change your taxation is if you purchase a joint life or single life annuity, as a joint life annuity must account for two life expectancies.

Deferred Income Annuities

Deferred Income Annuities are similar to Immediate Annuities in how they are taxed, with an exclusion ratio or taxable amount for non-qualified annuities.

Deferred Income Annuities, however, start making payments to you in the future and tend to pay more per year than an Immediate Annuity. As a result, the insurer will calculate your taxable amount a bit differently.

The distribution period (or multiple) used to calculate your taxable portion is based on the year in which you start receiving income. So even if you purchase your Deferred Income Annuity at 60, the insurer will use your age when you start receiving income (say 65) to determine your distribution period.

Luckily, insurers again do this calculation for you. You don’t need to worry about calculating your taxable income; it will be a part of your initial annuity quote.

Can the Tax Treatment of an Income Annuity Help You?

Yes, absolutely. This exclusion ratio is commonly used to spread out the tax burden of tax-deferred products like a Multi-Year Guarantee Annuity (MYGA) or Fixed-Index Annuity (FIA).

We have an article dedicated to how income annuity tax treatment can help manage deferred annuity earnings. But let's outline how you could use an Immediate Annuity to spread out this tax burden:

  1. Purchase an Immediate Annuity with your MYGA using a 1035 exchange (tax-free)
  2. Get income from your Immediate Annuity either for life or period of time
  3. Your Immediate Annuity income is equally distributed over the life of the annuity, effectively spreading out your tax burden

This annuity tax strategy is used by many retirees to manage earnings from deferred annuities. It uses income annuity tax rules to your advantage while also capitalizing on the other benefits of an Immediate Annuity.

Questions About Income Annuity Taxation

If you have questions about how an income annuity would be taxed (or not taxed!), call our annuity experts at (866) 866-1999. We’ll give you honest answers to your questions and help you understand how an income annuity will contribute to your taxes. We’re happy to help you.

+Frequently Asked Questions
How are income annuities taxed?

Income annuities are evenly taxed over the payout period of the annuity contract. This effectively distributes your tax-burden over the entirety of your annuity contract. This payout period may be your lifetime or a set period of time, depending on how you set up your annuity.

What happens when I get my non-qualified premium back from my income annuity?

With a non-qualified annuity, when you get your original post-tax premium paid back to you in full, your entire payment becomes taxable. This is because all of your payments at this point are earnings.

Are qualified and non-qualified income annuities taxed differently?

Yes. Qualified annuities could either be Traditional IRA or Roth IRA. If they are Traditional IRA, that means they have never been taxed before (are pre-tax) and your payments are therefore fully taxable as income. Payments from a Roth IRA annuity are never taxable, as this is the benefit of a Roth IRA.

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:

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Comments (16)

  1. Hersh Stern (ImmediateAnnuities.com)
    2016-02-09 15:55:45

    Hi Hugh-

    Yes. I looked up the quotes you created at our web site. For "source of funding" you describes the premium as "Savings" which typically is after-tax money. Now, on the page with quotations you'll see a column titled "Taxable Portion." This is the amount of taxable interest or gains you earn each month. Say you're in the 20% tax bracket. Then the amount each month you owe to Uncle Sam would be 20% of the "taxable portion."

    If, on the other hand, you decide to buy your annuity with IRA or 401k money, then the full amount of each monthly payment would be taxed as ordinary income.

    Hersh

  2. Hugh
    2016-02-09 15:55:01

    Is the monthly benefit taxed as regular income?

  3. Hersh Stern (ImmediateAnnuities.com)
    2015-08-10 09:17:24

    Hi Mia-

    1. Yes, you can roll over your 401k to an immediate annuity tax free. Read more about this here:

    https://www.immediateannuities.com/roll-over-ira-or-401k/

    2. Monthly income from your immediate annuity which was purchased with pre-tax 401k money is subject to ordinary federal income tax.

    Regarding California income tax on retirement income: Some states exclude all or a portion of income withdrawn from an IRA or 401k. However, there are at least five states which offer no safe haven for retirement income. California is one of the five. California also imposes a 2.5% penalty for those who withdraw from a retirement plan before age 59 1/2. This is in addition to the 10% pre-59-1/2 federal penalty.

    Hersh

  4. Mia
    2015-08-10 09:16:22

    1. Funds from my 401K rolled over to an Immediate Annuity, is this tax free from the IRS & State of CA?

    2. Monthly income from Immediate Annuities, is this Taxed by the IRS & State of California?

  5. Hersh Stern (ImmediateAnnuities.com)
    2015-07-27 10:44:31

    Hi Mike,

    If you bought your annuity with after-tax savings, then income tax is owed only on the gains. Taxes are at your ordinary income tax rate, not capital gains rate.

    If you bought your annuity with IRA or 401k pre-tax money, then tax is owed on the whole lump sum unless you roll it over into another tax-qualified account within 60 days. Again, taxes are at your ordinary income tax rate.

    Hersh

  6. Mike
    2015-07-27 10:43:20

    How much federal tax do I have to pay on a fixed annuity in which there is no history of withdrawals and I withdraw at once in a lump sum all the annuity?

  7. Hersh Stern (ImmediateAnnuities.com)
    2015-06-05 16:05:10

    Hi Dan-

    Any conversation about income taxes on an immediate annuity payment must start by defining the tax status of the premium dollars used to buy that annuity. If the source was an IRA or 401k then all the income distributed by that annuity will be taxable for as long as you and your spouse receive income from it.

    If you pay for your annuity with after-tax savings then the IRS recognizes that a part of your monthly income is really your own after-tax premium being paid back to you. So the IRS does NOT require you to pay income tax on that amount. You only owe income tax on the new interest you earn which had not been previously taxed.

    When you shop for an annuity at our firm we tell you up-front what portion of each check is taxable income and how much is not subject to any income tax.

    The non-taxable portion or percentage is known as the "exclusion ratio." This percentage remains unchanged each month for the duration of your annuity UNTIL you and your spouse have recouped ALL of your original after-tax investment (aka your "cost basis" in the contract).

    From then on your monthly income is considered to be all gains (i.e., all new earned interest) and therefore subject to income taxes.

    -Hersh

  8. Dan
    2015-06-05 16:04:16

    I will be 63 and my spouse 56 when we begin our joint life immediate annuity. Please discuss taxes if my spouse continues to receive income from this annuity after I die.

  9. Hersh Stern (ImmediateAnnuities.com)
    2015-05-21 10:26:31

    Hi Cynthia-

    Good to hear from you, too.

    Briefly, taxable income is similar to interest earnings that you may receive on a bank account and for which the bank sends you a Form 1099 at the end of the year. Similarly, the insurance company sends you a 1099 which tells you how much of the total income you got from your annuity that year was taxable. So, if you are in the 25% federal tax bracket, then 25% of this "taxable income" amount on your Form 1099 needs to be paid to Uncle Sam.

    -Hersh

  10. Cynthia
    2015-05-21 10:25:25

    I received your immediate annuity quotes and wondered what the column titled "taxable interest portion" means in practical terms (what records do I keep, for example)?

  11. Hersh Stern (ImmediateAnnuities.com)
    2014-11-04 16:54:43

    Hi Bev-

    This is a great question and I simply don't know the technical answer. I did check comparative quotes from the only two companies I know that market CPI increases in their deferred income annuities. These quotes (from American General and Principal Financial) indicate that whatever method they are using both companies came up with remarkably similar calculations for the excluded amounts.

    American General offered $2,133 per month with an excluded amount of $1,657.
    Principal Financial offered $2,001 per month with an excluded amount of $1,645.

    So my best guess is that the IRS is providing insurance companies with guidelines for how to arrive at this calculation in spite of the uncertainty about the level of future increases in the CPI. Thanks for asking.

    Hersh

  12. bev
    2014-11-03 20:32:16

    with an income annuity that has a COLA based on CPIU how is the non-taxable portion of each payment computed (since it is not possible to compute the expected payments over the annuitants life time because the cost of living adjustments to be made over the years are not known)?

  13. Hersh Stern (ImmediateAnnuities.com)
    2014-11-03 19:40:10

    Hi Wendell-

    Nice to hear from you, too.

    Typically, the insurance company will request the money from your existing Roth IRA custodian. This is done via a Transfer Authorization form you sign at the time you sign the application (we can send you those forms). Keep in mind that your Roth IRA must be "qualified," meaning, the account is at least 5 years old for payments you receive from the immediate annuity to be tax-free. If you have further questions about this, call me at 800-872-6684.

    Hersh

  14. Wendell R.
    2014-11-03 16:07:19

    Thanks for the tax info. I have a Roth IRA. If I were to get an immediate annuity would I withdraw the money from my Roth IRA and then buy the annuity, or would the company issuing the annuity directly withdraw the funds from my Roth IRA (with my permission of course)?

  15. Hersh Stern (ImmediateAnnuities.com)
    2014-10-07 16:10:53

    Hi Brad,

    With most companies, there is a section on the annuity application where you can elect (it's at your discretion) whether or not to have the insurance company withhold a specific dollar amount or percentage of each payment for federal income taxes. Some companies use a W-4P form, instead, which is the official IRS form used for withholding from pension or annuity payments. So you can be 100% assured that the IRS will get paid.

    Regarding the withholding of state income taxes, some companies do and some don't handle this. The state amounts needed to be withheld are usually very small relative to the gross amount of your monthly annuity payment.

    -Hersh

  16. Brad
    2014-10-07 14:52:01

    Will the annuity company withhold for Federal and state income taxes? Can I be assured that the IRS gets paid? How do the "mechanics" of this work?