Annuity Taxes

(How much do you get to keep?)

Reviewer: Jeffrey Green Written by Jeffrey Green
Reviewer: Jeffrey Green
Written by Jeffrey Green

Jeff Green has held a variety of sales and management roles at life insurance companies, Wall street firms, and distribution organizations over his 40-year career.  He was previously Finra 7,24,66 registered and held life insurance licenses in multiple states. He is a graduate of Stony Brook University.

Reviewed by Neel Lane
Reviewed by Neel Lane

Neel Lane is an independent contract paralegal who specializes in Medicaid and VA benefits. He helps people access and maximize the benefits that they're entitled to. He has over 30 years of experience in this area.

Updated
Annuity taxes

Uncle Sam wants us to save for retirement. That’s why annuities have special features and tax benefits. Where there are tax benefits, there are usually strings attached. Annuities are no exception.

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So what exactly is Uncle Sam’s share of your annuity?

Taxes on Traditional Qualified Annuities

Traditional qualified annuities are part of traditional pension plans and IRAs.  Contributions to traditional qualified annuities are made with pre-tax dollars. Generally, proceeds received from traditional qualified annuities are 100% taxable at ordinary rates.

Loans and sales are not permitted from an IRA. Loans may be available from a traditional qualified annuity in a pension if the proceeds are used to purchase a home or are repaid within 5 years. Loan proceeds are not taxable under the exceptions.

Taxes on Roth Plan Qualified Annuities

Roth plan qualified annuities are part of Roth pension plans and IRAs. Usually, proceeds received from Roth plan qualified annuities are tax-free.

Loans and sales are not permitted from an IRA. Loans may be available from a traditional qualified annuity in a pension if the proceeds are used to purchase a home or are repaid within 5 years. Loan proceeds are not taxable under the exceptions.

Taxes on Non-Qualified Annuities

Non-qualified annuities are personally owned and paid for with after-tax dollars.

Non-qualified annuities are taxed at ordinary income rates.

Annuity income is partially taxable. The amount of the annuity payment that is considered principal is excluded from taxable income. The exclusion is calculated based on the expected number of payments. Withdrawals are taxed as interest first until the growth is exhausted.

Loans are taxed as withdrawals. Surrenders are taxed based on the surrender value minus total interest paid.

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Penalty Taxes

Traditional qualified, Roth-qualified and non-qualified annuities all have a 10% penalty tax for withdrawals before age 59-½.

Both plans also have a 10% penalty for withdrawals taken before the end of five years.

Taxes on Annuities at a Glance

Below is a summary chart of the tax impact for the different plans and transactions.


Non-Qualified Qualified Qualified/Roth 
Contributions After-tax. Unlimited Pre-tax. Limits for IRAs and qualified plans apply. After-tax. Limits for IRAs and qualified plans apply.
Growth  Tax-deferred Tax-deferred Tax-deferred
Surrender  Gain is taxed at ordinary rates. All proceeds taxable Tax-free
Annuity Income  Partially taxable at ordinary rates 100% taxable at ordinary rates Tax-free
Withdrawals  Withdrawals are gain first. Gain is taxed at ordinary rates. 100% taxable at ordinary rates Tax-free
Loans  Loans are considered withdrawals. Gain first is taxed at ordinary rates. IRA loans not permitted. Pension plans may have exceptions for home purchase and loans repaid in 5 years. IRA loans not permitted. Pension plans may have exceptions for home purchase and loans repaid in 5 years.
Death Benefits Gain is taxed at ordinary rates. Proceeds will be taxed as "gain first." Rules for inherited traditional IRAs and qualified plans apply. Rules for inherited Roth IRAs and plans apply.
Sales  Proceeds in excess of basis taxed at ordinary rates. N/A N/A
Penalties 10% for withdrawals before age 59-1/2 10% for withdrawals before age 59-1/2 10% for withdrawals before age 59-1/2 Penalty for withdrawals prior to  end of the 5th year
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The Bottom Line

Annuities are a financial tool that offers tax-deferred growth and in some cases tax-favored income. Be sure to consult your professional advisor for tax and legal advice.

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