Tax Law and Annuities

As long as your money stays in the annuity, it will continue to grow and not be subject to any taxes. Taxation occurs whenever money is taken out of the annuity by withdrawing, or annuitizing.

Taxation occurs on the interest earned, and it is taxed at ordinary income rates. So the tax bracket you are in when you withdraw money from the annuity, determines the amount of tax that will be paid on your earnings.

In addition, most distributions made to you before you reach age 59½ are subject to an additional tax penalty of 10%. So if you are under age 59½, then if would probably be a better idea to borrow money from your annuity, instead of withdrawing or annuitizing.

Note: The 10% early withdrawal penalty does not apply to immediate annuity contracts. So you can annuitize an immediate annuity at any age without fear of a tax penalty.

An annuity, IRA, or life insurance contract can usually be exchanged for a new annuity without any taxation. This is allowed by the IRS like kind exchange rules (Section 1035). However, be aware that most annuities do have penalties for cashing them in before a stated time period has elapsed (usually between 5 and 10 years).

Summary

We've talked about common features of annuities, the three different types of annuities, how indexed annuities work, and some of the tax rules governing annuities.

If you would like to return to any of the previously discussed annuity topics, use the right column index to go to the topic of your choice.