Home › Annuities › How Annuities Are Taxed
Annuity TaxesQualified vs Non-QualifiedRolloversTax-deferred is not tax-free.
Annuity growth is not taxed while it stays in the contract. What you owe when money comes out depends first on one question: was the annuity bought with qualified (pre-tax) money or non-qualified (after-tax) money?
Qualified vs non-qualified annuities.
A qualified annuity is bought with pre-tax retirement money: an IRA, or a 401(k) or 403(b) rolled into one. A non-qualified annuity is bought with money you have already paid tax on, such as savings, a maturing CD or the proceeds of a home sale. Same product, very different tax treatment.
| Qualified (IRA / 401(k) money) | Non-qualified (after-tax savings) | |
|---|---|---|
| What is taxable when it comes out | Generally all of it, as ordinary income (Roth money follows Roth rules) | Only the earnings. Your premium comes back tax-free. |
| Order of withdrawals | Everything is taxable, so order does not matter | Earnings come out first and are taxed first, then premium |
| How much you can put in | Limited by the plan or IRA contribution and rollover rules | No IRS limit. Insurers set their own maximums. |
| Required minimum distributions | Yes, starting at your RMD age | No RMDs during the owner's lifetime |
| Withdrawals before 59½ | 10% IRS additional tax on the taxable amount, with some exceptions | 10% IRS additional tax on the earnings withdrawn, with some exceptions |
| Annuitized income | Generally fully taxable | Split by the exclusion ratio into tax-free premium and taxable interest |
Five rules that cover most annuity tax questions.
Growth is tax-deferred.
Interest credited inside a deferred annuity is not taxed year by year. A CD sends you a 1099 every year; an annuity does not until money comes out.
Gains are ordinary income.
Annuity earnings are taxed at your ordinary income tax rate when withdrawn, not at capital gains rates, however long you held the contract.
Early withdrawals cost 10% more.
Taxable amounts withdrawn before age 59½ generally carry a 10% IRS additional tax, on top of income tax. Exceptions include death, disability and a series of substantially equal periodic payments.
RMDs apply to qualified money.
Annuities inside an IRA are subject to required minimum distributions, currently starting at 73 for most retirees and rising to 75 for people born in 1960 or later.
Heirs inherit the tax.
Annuities do not receive a step-up in basis at death. Beneficiaries owe ordinary income tax on the gain. A surviving spouse can usually continue the contract as their own; other beneficiaries choose a payout schedule within IRS rules.
A 1035 exchange moves money tax-free.
You can move from one annuity to another, or from a life insurance policy to an annuity, without triggering tax. Check the surrender charges on the old contract and the new surrender period before you do.
Should you roll your 401(k) into an annuity?
Sometimes, for part of it. The mechanics: after you leave an employer (or reach an age when your plan allows in-service withdrawals), a direct rollover moves the money from the 401(k) into an IRA, and that IRA can own an annuity. Done as a direct rollover, no tax is withheld and nothing is owed.
The question that matters is why. Inside an IRA, an annuity's tax deferral adds nothing: the IRA is already tax-deferred. So the only good reason to roll 401(k) money into an annuity is the guarantee: protection from market losses, or income you cannot outlive. If neither of those is the goal, an annuity is the wrong home for the money.
Before rolling anything, compare what you give up in the plan (its fund lineup and costs, and any features unique to the plan) with what the annuity adds, and read its surrender schedule. A rollover is usually best used for the slice of savings meant to cover your essential income, not the whole balance.
What is a tax-sheltered annuity?
Tax-sheltered annuity, or TSA, is the older name for a 403(b) plan: the retirement plan offered by public schools, hospitals and many nonprofits. Despite the name, today's 403(b) plans can hold mutual funds as well as annuities. The tax rules follow the plan, so money coming out of a 403(b) annuity is generally taxable as ordinary income.
Taxes are personal. We explain how the rules work and coordinate with your tax professional; we do not give tax advice.
Quick answers.
What is a non-qualified annuity?
A non-qualified annuity is bought with money you have already paid income tax on, such as savings or a maturing CD. Its earnings grow tax-deferred, and when you withdraw, only the earnings are taxable; your original premium comes back tax-free. Non-qualified annuities have no IRS contribution limit and no required minimum distributions during the owner's lifetime.
What is a qualified annuity?
A qualified annuity is one funded with pre-tax retirement money, such as an IRA or a 401(k) or 403(b) rollover. Because none of the money has been taxed yet, withdrawals are generally taxable in full as ordinary income, and required minimum distributions apply.
How are annuity withdrawals taxed?
From a non-qualified annuity, withdrawals are treated as coming from earnings first, taxed as ordinary income, until all the earnings are out; after that, you are getting your premium back tax-free. From a qualified annuity, withdrawals are generally fully taxable. Taxable amounts taken before age 59½ may also carry a 10% IRS additional tax.
Are annuities taxed as capital gains?
No. Annuity earnings are taxed as ordinary income when withdrawn, regardless of how long you have owned the contract or whether the interest was linked to a stock index.
Do annuities have required minimum distributions?
Annuities held inside an IRA or employer plan do, starting at your RMD age, currently 73 for most retirees and 75 for people born in 1960 or later. Non-qualified annuities do not have RMDs during the owner's lifetime, although contracts set a maximum age by which income must begin.
Do beneficiaries pay tax on an inherited annuity?
Yes, on the gain. Annuities do not get a step-up in basis, so beneficiaries owe ordinary income tax on any earnings above the original premium. A surviving spouse can usually continue the contract; other beneficiaries choose among payout options within IRS rules, which affect how quickly the tax is due.
Should I roll my 401(k) into an annuity?
Only if you want what an annuity guarantees, protection from market losses or lifetime income, because inside an IRA the annuity's tax deferral adds nothing. Use a direct rollover to avoid withholding, compare what you give up in the plan, read the surrender schedule, and consider using only the portion meant to cover essential income.
What is a 1035 exchange?
A 1035 exchange, named for the section of the tax code that allows it, moves money from one annuity to another, or from a life insurance policy to an annuity, without paying tax on the gain. Before exchanging, check the surrender charges on the old contract and the new surrender period you would be starting.
Check a rollover before you sign anything.
Bring your 401(k) or IRA statement, or the annuity you already own. We will show you what the move would cost in surrender charges and what it would actually add, and if the honest answer is to leave it where it is, we will say so.
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Important: Annuities are insurance contracts, not bank deposits. They are not FDIC insured and are not guaranteed by any bank or government agency. Guarantees are backed by the financial strength and claims-paying ability of the issuing insurance company. Withdrawals above a contract's free amount during the surrender period may be subject to surrender charges and, on some contracts, a market value adjustment. Taxable amounts withdrawn before age 59½ may also be subject to a 10% IRS additional tax. Fixed indexed annuities are not a direct investment in the stock market or in any index. Products, features and availability vary by carrier and by state. iCoach Solutions offers fixed, fixed indexed and income annuities. We do not offer securities, including variable annuities, and we do not give investment, tax or legal advice: talk with a qualified tax professional about your own situation. This page is general education, not a recommendation.