Tax-Deferred Growth
Earnings within an annuity generally grow tax-deferred, meaning you don't pay taxes on growth until you take a withdrawal or begin receiving income payments.
Non-Qualified Annuities (After-Tax Money)
When you withdraw from a non-qualified annuity, earnings are generally taxed as ordinary income on a last-in-first-out (LIFO) basis — meaning gains are typically withdrawn (and taxed) before your original principal.
Qualified Annuities (Pre-Tax Retirement Money)
Annuities funded with pre-tax retirement money (like an IRA) are generally taxed as ordinary income on the entire withdrawal amount, similar to other distributions from that type of retirement account.
Early Withdrawal Considerations
Withdrawals taken before age 59½ may be subject to a 10% federal early withdrawal penalty on the taxable portion, in addition to any contract-level surrender charge — these are two separate and distinct costs.
Key Takeaways
- Annuity earnings generally grow tax-deferred until withdrawal.
- Non-qualified annuity withdrawals are taxed LIFO — gains come out first.
- Withdrawals before 59½ may trigger a separate IRS early withdrawal penalty, distinct from any surrender charge.
This is a general overview of common tax treatment, not tax advice. Tax laws are complex, change periodically, and depend on your individual circumstances. Consult a qualified tax professional before making decisions based on tax considerations.
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