How are annuity payments taxed when I take money out?

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Annuity earnings are tax-deferred while they stay in the contract, but when you take money out, you generally owe ordinary income tax on the taxable portion. If you withdraw money before age 59½, you also may have to pay a 10% tax penalty. Under current federal law, income tax on annuities is deferred. That means you are not taxed on interest or investment returns while the money remains in the annuity. Tax-deferred does not mean tax-free. The taxes are generally due later, when you take a withdrawal, receive an income stream, or receive annuity payments. For annuity payments, part of what you receive may be treated as a return of the premium you paid, and you would not pay taxes on that part. Another part is treated as interest you earned, and you must pay taxes on that portion when you withdraw the money. The NAIC guide also notes that most states' tax laws on annuities follow federal law. If the annuity is used to fund an IRA or certain employee retirement plans, the tax treatment can be different. In those cases, when you take money out, you may pay ordinary income tax on all of the money you receive, not just the interest or investment return. The NAIC guide recommends speaking with a professional tax advisor about your individual situation. After death, there are also tax rules that can apply to distributions to survivors or beneficiaries. The Internal Revenue Code has rules about distributions after the death of a contract holder, and survivors will typically owe income taxes on any death benefit they receive from an annuity.