How an Income Annuity Can Help Distribute Your Tax Burden

Written by Ariel Stern Updated October 10, 2025

One of the great benefits of deferred annuities like a Multi-Year Guarantee Annuity (MYGA) or Fixed Index Annuity (FIA) is their ability to grow tax-deferred. This maximizes your earnings and reduces your taxable income.

However, when it comes time to tap into these annuities, they are paid out Last-In, First-Out (LIFO), meaning that your interest is paid out first. This can frontload your taxable income which can create problems for retirees.

The good news is that an Income Annuity can help you spread your tax burden more evenly — while also providing several other benefits. This strategy is often used by retirees who want to manage taxable income thresholds that affect Social Security or Medicare premiums. Let’s explore how the most common type of income annuity, an Immediate Annuity, accomplishes this.

A Good Problem To Have: Your MYGA Grew Too Much

Let’s say you bought a $50,000 non-qualified annuity with your regular savings in preparation for retirement. To maximize your earnings, you used a 1035 exchange at the end of each MYGA term to get the best interest rate while carrying over your tax deferral.

Your money grew at an average rate of 4.00% over a fifteen-year period, yielding you $90,047. This means that you have $40,047 in taxable earnings in your MYGA, with $50,000 of your original premium being non-taxable.

You are now ready to use this MYGA for your retirement. The problem? You have a lot of untaxed earnings in this MYGA.

If you just withdrew your full MYGA balance in one year, you’d add $40,047 to your taxable income — which could bump you into a higher tax bracket and affect the taxation of your Social Security or Medicare premiums.

Your Solutions: Self-Manage Your Withdrawals or Buy An Immediate Annuity

You have two other options available to you. You can self-manage your withdrawals directly from your MYGA or 1035 exchange your MYGA into an Immediate Annuity.

Option 1: Self Managed Withdrawals

You can tell your insurer that you are not renewing your annuity contract. Insurers will often allow you to hold your money in a holding account while you make these withdrawals.

Let’s say your insurer will allow you to hold your MYGA value in a holding account for five years at 1.5%. Your plan is to take withdrawals every year to empty your account.

If you did this, you would be frontloading your tax burden. MYGAs are paid out Last-In, First-Out (LIFO), meaning that your interest is paid out first. If you did this, your tax burden would be high in the first few years of withdrawals.

The chart below illustrates how your taxable income is frontloaded under this approach — shown in light orange.

Option 2: Immediate Annuity

You can capitalize on the tax treatment of Immediate Annuities. If you go this route, your tax burden is spread out through the duration of the annuity.

Effectively, this means that your income and taxable amount are equal each year. If you bought a 5 Year Period Certain Immediate Annuity, you might expect to receive $19,968 annually with $9,972 of it being taxable.

You are still paying your full taxable amount, but it is spread throughout the five year period. See the chart below with dark blue representing your income, and light blue representing your taxable portion.

Benefits of Using An Income Annuity To Spread Out Your Taxes

There are other benefits to using an Income Annuity too. Not only does an Income Annuity provide a tax-efficient annuity strategy, but in the example above you also make more money over the five-year period.

In this example, the Immediate Annuity produces $99,840 over five years, compared to $92,789 from self-managed withdrawals.* While these numbers are hypothetical, it is common for Immediate Annuities to pay a higher internal rate of return (under the “Period Certain” option) than a simple holding account in a MYGA.

In addition to spreading out your tax burden, with an Income Annuity you can:

• Get guaranteed lifetime income (with your age determining your income rate)
• Provide for beneficiaries and/or loved ones if you die early (requires selecting a payout option with a death benefit or joint annuitant)
• Have a “hands-off” financial product that manages itself

The Bottom Line: Converting part of your MYGA into an Income Annuity can give you predictable income, reduce tax spikes, and make retirement income planning easier.

Get An Income Annuity Quote Today

If you want to see what you could from an Income Annuity, simply fill out the blue calculator on this page. It will show you how much income you could expect to receive each month. And if you want to explore this tax strategy for spreading out your tax burden from a deferred annuity, call us at (866) 866-1999. We’ll run custom quotes for you with your cost-basis, showing you exactly how much you could earn and how much would be taxable.

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 939 (12/2024), General Rule for Pensions and Annuities” Internal Revenue Service. Revised December 2024.
• Wastler, A. and Brand, S. “How is annuity income taxed? It depends” MassMutual. January 6, 2025.

*Annuity rates change frequently. All figures used are based on a snapshot of market conditions. MYGA holding rates may change in relationship to Immediate Annuity rates. Be sure to check current rates when making financial decisions and consult with a tax professional.