The 60-second version
- Annuities grow tax-deferred, but gains are taxable as ordinary income when distributed.
- Qualified annuities are generally fully taxable on distribution; non-qualified annuities tax earnings while basis returns tax-free.
- Non-qualified withdrawals use LIFO: gains come out first. Annuitized payments use an exclusion ratio.
- Before age 59 1/2, taxable non-annuitized distributions can face a 10% penalty. Qualified money also brings RMD and QLAC planning.
Start here
Are annuities taxable? Yes - but the bill is usually delayed
Annuities generally grow tax-deferred. You do not pay tax every year on credited interest or growth inside the contract. But tax-deferred does not mean tax-free. When money comes out, the taxable portion is taxed as ordinary income at your regular federal rate, not as long-term capital gains.
In one sentence
The first question is where the money came from. A qualified annuity inside an IRA, 401(k), or similar retirement account follows that account's tax rules. A non-qualified annuity funded with after-tax dollars has a basis, so only the gain is taxable.
The core distinction
Qualified vs non-qualified: the funding source decides the tax
A qualified annuity is funded with pre-tax retirement money. Because those dollars generally have not been taxed yet, withdrawals are generally fully taxable. A non-qualified annuity is funded with after-tax money; your basis has already been taxed, so the tax system looks for the growth above basis.
| Question | Qualified annuity | Non-qualified annuity |
|---|---|---|
| Funded with | Pre-tax retirement money such as IRA or 401(k) dollars. | After-tax dollars outside a qualified retirement plan. |
| Taxable on withdrawal | Generally the full distributed amount. | Earnings/gains first; basis is tax-free when recovered. |
| RMDs | Yes, generally starting at age 73 under current rules. | No RMDs for the non-qualified contract itself. |
| Helpful next read | QLAC rules | Non-qualified annuities |
Common error to ignore
The part people miss
How withdrawals are taxed: LIFO vs the exclusion ratio
For a non-qualified annuity, the method of distribution matters. If you take a withdrawal or surrender the contract, the IRS generally treats earnings as coming out first. That is LIFO: last in, first out. If you annuitize, each payment is split between taxable earnings and tax-free return of basis using the exclusion ratio.
| How money comes out | Non-qualified tax treatment | Planning effect |
|---|---|---|
| Withdrawal or lump sum | LIFO: gains are ordinary income until exhausted; basis comes after. | Can concentrate taxable income in one year. |
| Annuitized payments | Exclusion ratio: investment in contract divided by expected return. | Spreads the tax-free basis portion across expected payments. |
| Qualified distribution | Generally fully taxable, regardless of withdrawal or income format. | Coordinate with IRA, 401(k), RMD, and withholding rules. |
In one sentence
Exclusion ratio
Compare income paths before you pick the tax path
SPIA, DIA, FIA riders, and annuitization can solve different income jobs. Compare the income first, then bring the tax timing to a professional.
Timing rules
The 10% early-withdrawal penalty and RMDs
If taxable annuity money comes out before age 59 1/2, the IRS generally adds a 10% early-distribution penalty unless an exception applies. Separately, qualified annuities are subject to required minimum distribution rules, generally starting at age 73. Non-qualified annuities do not have RMDs, though contract withdrawals can still have tax and surrender-charge consequences.
| Rule | Applies to | What it does |
|---|---|---|
| 10% early penalty | Taxable portion before age 59 1/2, with exceptions. | Adds a penalty on top of ordinary income tax. |
| RMDs at 73 | Qualified retirement money. | Forces taxable distributions based on IRS life-expectancy tables. |
| QLAC | Qualified deferred income annuity that meets IRS rules. | Can defer RMDs on that portion until a later income start date. |
RMD divisors should come from IRS Pub. 590-B, Appendix B. This page uses the versioned Pub. 590-B Table III data for its RMD context, while leaving full RMD dollar calculations to a tax professional or dedicated RMD workflow.
Need the QLAC angle?
Deferred income and QLAC quote paths can be useful when RMD timing is part of the plan.
For beneficiaries
How annuities are taxed at death
An inherited annuity is not treated like inherited stock in a taxable brokerage account. There is generally no step-up in basis. For a non-qualified annuity, the beneficiary owes ordinary income tax on the gain above basis when that gain is distributed; the remaining basis is not taxed again. Qualified annuities follow qualified-account beneficiary rules.
| Beneficiary option | Tax effect | Watch |
|---|---|---|
| Spousal continuation | A surviving spouse may be able to continue the contract and keep deferral. | Contract and account-type rules matter. |
| Stretch or installments | Spreads distributions, which can spread taxable gains across years. | Beneficiary eligibility and payout rules matter. |
| 5-year option | Can require the contract to be emptied within a fixed window. | Taxable gains may be bunched if delayed. |
| Lump sum | Fastest access, but taxable gain lands in one year. | Often the highest bracket risk. |
Do not assume
For a deeper child guide, see the annuity taxation-at-death page.
Planning levers
How to lower the tax bill legally
You usually cannot erase annuity tax, but you can often manage when it arrives and how concentrated it is. That is the job for a tax professional who can see Social Security, pensions, IRAs, Roth accounts, brokerage gains, state tax, and estate goals together.
| Strategy | How it helps | Related page |
|---|---|---|
| Use lower-income years | Take taxable gains when your marginal rate is lower. | Avoid-tax guide |
| Annuitize or spread payments | Can spread basis recovery and taxable gains across years. | SPIA quotes |
| Consider a 1035 exchange | Can move from one non-qualified annuity to another without current gain recognition if done correctly. | FIA rates |
| Use QLAC rules carefully | Can delay RMDs on part of qualified money if the contract qualifies. | DIA and QLAC quotes |
| Compare the base rate | Better rates can make timing more valuable, but rates are not tax advice. | MYGA rates |
Find the product first, then solve the tax timing
Compare live MYGA, FIA, SPIA, and DIA paths, then bring the distribution plan to your tax professional.
Quick answers
Frequently asked questions
Are annuities taxed as ordinary income or capital gains?
Annuity earnings are generally taxed as ordinary income when distributed, not as long-term capital gains. That is one of the main tradeoffs of tax-deferred annuity growth.
Is a non-qualified annuity tax-free?
No. Your after-tax basis can come back tax-free, but earnings are taxable as ordinary income. For non-annuitized withdrawals, LIFO generally taxes earnings first.
What is the 10% annuity penalty?
If taxable annuity money is distributed before age 59 1/2, a 10% federal penalty may apply unless an exception applies. The estimator treats this as a simplified federal rule and is not tax advice.
Do annuities have RMDs?
Qualified annuities funded with IRA or other retirement-plan money are generally subject to RMD rules starting at age 73. Non-qualified annuities do not have RMDs. QLACs can defer RMDs on a qualifying portion of IRA money.
How are inherited annuities taxed?
Non-qualified annuities generally do not receive a step-up in basis. Beneficiaries owe ordinary income tax on gains when distributed, while after-tax basis is not taxed again. Spousal continuation, installment, stretch, 5-year, and lump-sum choices can change timing.
Is the calculator exact tax advice?
No. It is an illustrative federal estimate using simplified assumptions: one flat marginal rate, no state tax, LIFO for non-qualified withdrawals, Pub. 939 Table V for ordinary one-life annuitized examples, and a basic penalty rule. Confirm all results with a qualified tax professional.
General U.S. federal educational information as of June 18, 2026. Not tax or legal advice; confirm your situation with a qualified tax professional. Calculator outputs are illustrative estimates only. Assumptions: single flat federal marginal rate, no state tax, no surrender charges or withholding, LIFO for non-qualified non-annuitized distributions, Pub. 939 Table V for ordinary one-life annuitized examples, and a basic 10% early-withdrawal penalty rule. Source data: IRS Pub. 939 Tables V-VIII, Rev. December 2025, for General Rule expected-return multiples; IRS Pub. 590-B (2025), Appendix B, published January 21, 2026, for RMD denominators. More complex refund-feature, joint-life, temporary-life, state-tax, withholding, and beneficiary cases require professional review.