Tax year 2026  ·  Reviewed October 7, 2026  ·  By Nazim Lokhandwala

PDF

Printable checklist for your desk

Print this checklist and bring it to your tax preparer before you buy, exchange, or withdraw.

Download the PDF (large print) Annuity tax checklist  ·  Opens in any PDF viewer  ·  No sign-up needed

The short version. Annuity earnings grow tax-deferred, not tax-free. You pay ordinary income tax when you take money out or receive payments. For a non-qualified annuity (bought with after-tax money) withdrawals are generally taxed earnings first. Taking money out before age 59½ can add a 10% additional tax. A tax professional should review your situation before you buy or withdraw. [1, 2]

Qualified and non-qualified

  • Non-qualified: bought with after-tax dollars. Only the earnings are taxed when they come out.
  • Qualified: held inside an IRA or workplace plan. Pre-tax money is taxed when distributed, and the annuity gets no extra tax benefit beyond the plan's own. [3]

Withdrawals before income payments start

For a non-qualified annuity, IRS Publication 575 says the amount withdrawn is allocated first to earnings (the taxable part) and then to your cost (the tax-free part). Contracts bought before August 14, 1982 follow a different rule. [4, 5]

The 10% additional tax

For a non-qualified annuity, the Internal Revenue Code adds a 10% tax on the portion of a withdrawal that is includible in income, with exceptions. Among the main exceptions in the law are: [5]

  • Age 59½ or older
  • On or after the holder's death
  • Because of disability
  • As part of substantially equal periodic payments for life or a life expectancy
  • Under an immediate annuity contract

Annuities inside an IRA or plan follow the retirement-account exceptions instead. See IRS Topic 557. Ask your tax professional which list applies to you. [6]

When you take income payments

If you convert an annuity into a stream of payments, part of each payment can be a tax-free return of your cost, based on an exclusion ratio. IRS Publication 575 gives an example: with $12,000 of cost and a $100 monthly exclusion, the tax-free part ends after 120 payments, and later payments are generally fully taxable. If you die before recovering your cost, the unrecovered amount is deductible on your final return. [4]

Moving to a different annuity: Section 1035

Section 1035 of the tax code lets you exchange one annuity contract for another without paying tax on the gain at that moment. A partial transfer can qualify under Revenue Procedure 2011-38 if no money is taken from either contract (other than annuity payments for ten years or more, or for life) for 180 days after the transfer. Tax-free does not mean cost-free: a new surrender period generally begins, and you may lose benefits of the old contract. See our surrender charges guide. [7, 8, 9]

Required withdrawals

An annuity held in an IRA or plan is subject to required minimum distribution rules. IRS Publication 590-B says special rules may apply when part of an IRA is used to buy an annuity. SECURE 2.0 also allows the annuity and non-annuity portions of an account to be combined for required withdrawals. Ask a tax professional how this affects the contract you are considering. See our required withdrawals guide. [10, 11]

The 3.8% net investment income tax

The IRS lists non-qualified annuities among the income that can count as net investment income, which is taxed at 3.8% above $200,000 of modified adjusted gross income for single filers and $250,000 for married couples filing jointly. [12]

When the owner dies

  • If the holder dies before payments start, the law generally requires the entire interest to be paid out within five years. A designated beneficiary can instead take payments over life or life expectancy if they begin within one year of death. A surviving spouse beneficiary is generally treated as the holder. [5]
  • The gain in the annuity is generally taxable to the beneficiary when received, and annuity gain generally does not receive the stepped-up basis that a house or stock might. Ask your tax professional how this applies. [5, 13]

Questions for your tax professional

  • Is this money qualified or non-qualified, and what is my cost basis?
  • What will each withdrawal look like on my tax return?
  • Does a 10% additional tax exception apply to me?
  • If I am moving from another annuity, does it meet the exchange rules?
  • How will my beneficiaries be taxed?

Plan a conversation

Frequently asked questions

Are annuity withdrawals taxed earnings first?

For a non-qualified annuity, IRS Publication 575 says the amount withdrawn is allocated first to earnings (taxable) and then to your cost (tax-free), with an exception for contracts bought before August 14, 1982.

Is there a penalty for withdrawing before 59 and a half?

A 10% additional tax can apply to the taxable portion of a withdrawal before age 59 and a half, with exceptions such as death, disability, and certain periodic payments.

What is a 1035 exchange?

Section 1035 lets you exchange one annuity for another without paying tax on the gain at that moment. A new surrender period generally begins, so compare the costs.

About this guide. This is general education, not tax, legal, or investment advice, and it is not a recommendation to buy or not buy any product. Nazim Lokhandwala is a licensed insurance professional who offers fixed and indexed annuity products. He does not offer variable annuities or registered index-linked annuities. This guide covers every type so you can compare, and an annuity is not the right choice for everyone. Annuity guarantees depend on the claims-paying ability of the issuing insurer. Product features, rates, and rules vary by company and by state, so read your contract and ask the seller to explain anything that is unclear.

Keep reading