How Are Annuities Taxed?

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Do I Owe Taxes on Money I Withdraw From My Annuity?

It depends on whether the annuity is in a taxable account or an IRA, as well as how you choose to take the withdrawals.

I contributed $100,000 to an annuity in 2007, and the account grew to $143,000. I recently withdrew $120,000 to buy a new house. How much of the withdrawal is taxable?

See Also: Are Annuities Right for You?

It depends on whether the annuity is in a taxable account or an IRA. If the annuity is in a taxable account, the first withdrawals are considered to be from earnings – which are taxed in your top income tax bracket – and any remaining withdrawals are considered a tax-free return of your principal. In your case, the first $43,000 of withdrawals is considered to be from taxable earnings, and the remaining $77,000 is a tax-free return of principal. (If you withdraw money before age 59½, you will also have to pay a 10% early-withdrawal penalty on the earnings portion of the withdrawal.)

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If you end up withdrawing more money later, after the account has grown more, the earnings portion will be recalculated. “The calculation is done each time a withdrawal occurs, based on gains at the time,” says Michael Kitces, a certified financial planner and director of wealth management for the Pinnacle Advisory Group in Columbia, Md.


If the annuity is in a traditional IRA and all of your contributions were tax-deductible, the entire withdrawal will be taxed at your top income tax rate, and it will be subject to the 10% early-withdrawal penalty if you’re younger than 59½.

When making decisions about annuity withdrawals from a taxable account, keep in mind that the way you take the money can affect the tax situation. If you had annuitized the account -– converted it to an income stream with payments spread either over your lifetime or over a certain number of years, rather than taking withdrawals whenever you’d like – then a portion of each payout is considered to be a tax-free return of principal and a portion is considered to be earnings, based on the length of time the payouts are scheduled to continue.

For example, if you have a life annuity with payouts that stop when you die, the payout period is the IRS’s life-expectancy number for someone your age. Divide your contributions by that life-expectancy number to determine how much of each payout is a tax-free return of principal; you’ll be taxed only on the portion of each payout above that amount. Your annuity administrator can help with the calculations.

See Also: 12 Ways to Go Broke in Retirement

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