Annuity tax treatment depends on whether the annuity is qualified (held in an IRA or 401k) or non-qualified (purchased with after-tax dollars). Non-qualified annuity: contributions are made with after-tax dollars; growth is tax-deferred; withdrawals are taxed as ordinary income on the gain only (LIFO — last in, first out). Qualified annuity (IRA): contributions may be tax-deductible; all withdrawals are taxed as ordinary income; subject to Required Minimum Distributions (RMDs) starting at age 73. Early withdrawal (before 59½): 10% IRS penalty plus ordinary income tax on the taxable portion.
Key Points
- Non-qualified annuity: after-tax contributions, tax-deferred growth, gain taxed at withdrawal
- Qualified annuity (IRA): all withdrawals taxed as ordinary income
- Non-qualified: only the gain is taxed, not the principal (cost basis)
- Early withdrawal before 59½: 10% IRS penalty plus ordinary income tax on gain
- Qualified annuities subject to Required Minimum Distributions starting at age 73
- Death benefit to beneficiaries: taxed as ordinary income on the gain