Retirement Literacy Foundation · Annuity Education

How Are Annuities Taxed?

By Hans Goldstein, founder, Retirement Literacy Foundation · Updated October 8, 2026

Short answer: Growth inside an annuity is tax-deferred: no tax until money comes out. When it does, the taxable part is taxed as ordinary income, not at capital gains rates. How much is taxable depends on whether the annuity is qualified (inside an IRA or 401(k)) or non-qualified (bought with after-tax money), and whether you take withdrawals or annuitize.

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Qualified annuities (inside an IRA or 401(k))

If the annuity is held inside an IRA, 401(k) or other retirement plan, the money usually went in pre-tax. So every dollar that comes out is taxable as ordinary income (except any after-tax basis you tracked on Form 8606). The usual retirement account rules apply: required minimum distributions, and the 10% early withdrawal tax before 59½ unless an exception applies. More on annuities in an IRA and RMDs.

Non-qualified annuities: withdrawals are gains first

A non-qualified annuity was bought with after-tax money, so your premiums (the investment in the contract) come back tax-free. But for contracts issued after August 13, 1982, ordinary withdrawals come out earnings first (IRC section 72(e)). Until all the gain has been withdrawn, every dollar you take is taxable.

Example: you put in $200,000 and the contract is now worth $260,000. The first $60,000 you withdraw is fully taxable as ordinary income. After that, withdrawals are a tax-free return of your $200,000.

Annuitized payments: the exclusion ratio

If you annuitize a non-qualified contract (turn it into scheduled payments), each payment is split into a tax-free part and a taxable part using an exclusion ratio: your investment in the contract divided by the expected total payments. Once you have recovered your full investment, later payments are fully taxable. If you die before recovering it, the unrecovered amount can be deducted on your final return.

The 10% early withdrawal tax

Taxable money taken out before age 59½ generally owes an extra 10% federal tax (IRC section 72(q) for non-qualified, 72(t) for qualified). Exceptions include death, disability, a series of substantially equal periodic payments, and payments from an immediate annuity.

Other rules that matter

Form 1099-R. The insurer reports distributions and the taxable amount on Form 1099-R.
Net investment income tax. The taxable part of a non-qualified annuity distribution counts as net investment income for the 3.8% tax above $200,000 of modified AGI (single) or $250,000 (joint). Qualified plan distributions do not. See NIIT.
Medicare and Social Security. Taxable annuity income raises your adjusted gross income, which can make more of your Social Security taxable and can push you over an IRMAA line.
Tax-free moves. You can move one annuity to another without tax using a 1035 exchange.
Heirs. No step-up at death; see inherited annuity taxes.
State tax. Most states tax annuity income like other income; a few exempt some retirement income.

Common questions

Are annuities taxed as capital gains?

No. The taxable part of an annuity payment or withdrawal is ordinary income, even if the growth came from an index or investment sub-accounts.

How can I avoid paying taxes on an annuity?

You cannot avoid the tax on the gain, but you can control when it is paid: spreading withdrawals over low-income years, annuitizing to use the exclusion ratio, or using a 1035 exchange to keep deferring. A qualified charitable distribution can also send IRA annuity money to charity tax-free after age 70 1/2.

Is the money I put into a non-qualified annuity taxed again?

No. Your premiums were already taxed, so they come back tax-free. Only the growth is taxed, and with ordinary withdrawals it comes out first.

More on annuities: How Do Annuities Work? A Plain-English Guide · Inherited Annuity Taxes · 1035 Exchange · Annuities in an IRA · Annuity Surrender Charges and How to Get Out of an Annuity · Types of Annuities and Their Pros and Cons · What Is a MYGA? Multi-Year Guaranteed Annuities Explained · Fixed Index Annuity Explained · Immediate Annuity (SPIA) Explained · Variable Annuity Explained · Annuity vs CD

Education only; nothing is sold here and no product is recommended. Hans Goldstein, founder of the Retirement Literacy Foundation, is also a licensed California insurance producer (#4273294). Tax rules depend on your situation; check with a tax professional before acting.