How is the income from an annuity taxed?

The taxation of annuity income depends on several factors, including the type of annuity, the source of the funds used to purchase the annuity, and the age of the annuitant. Here are some general rules regarding the taxation of annuity income:

  1. Tax-deferred growth: The earnings on an annuity are tax-deferred until they are withdrawn. When the annuity payments begin, the amount received is taxed as ordinary income.
  2. Non-Qualified Annuities: The funds used to purchase a non-qualified annuity are typically after-tax dollars. Therefore, only the earnings portion of the annuity payment is subject to income tax.
  3. Qualified Annuities: The funds used to purchase a qualified annuity are typically pre-tax dollars, such as those from an IRA or a 401(k). Therefore, the entire annuity payment is subject to income tax.
  4. Annuity Payout Options: The income from an annuity can be received in various ways, such as a lump sum, a series of payments, or as a life income. The tax treatment of these payments may vary depending on the payout option selected.
  5. Age-Based Rules: If the annuity payments begin before the age of 59 ½, a 10% early withdrawal penalty may apply to any taxable amount withdrawn from the annuity.

It is essential to consult with a tax professional to determine the tax implications of an annuity based on individual circumstances.