Are Annuities Taxable? How Annuity Taxes Work (2026)

Yes, annuities are taxable, but only the earnings, and only when you take money out. Your original after-tax investment (your basis) comes back tax-free, while the gains are taxed as ordinary income, not at the lower capital-gains rate.

How much you owe depends on whether the annuity is qualified (funded with pre-tax retirement money, such as a traditional IRA) or non-qualified (funded with after-tax savings), and on how you withdraw. This guide covers every scenario in plain English so there are no surprises at tax time.

How Are Annuities Taxed? The Basic Rule

Annuity earnings grow tax-deferred, so you owe nothing while the money sits inside the contract. Taxes apply when you withdraw funds, receive income payments, or surrender the contract, and the gains are always taxed as ordinary income regardless of how long you held the annuity. How much is taxable depends on how the annuity was funded:

Are Annuity Withdrawals Taxable?

Yes, partly or fully, depending on the contract type and whether you have annuitized (converted the contract to a stream of payments).

For non-qualified annuities, withdrawals before annuitization follow LIFO (last-in, first-out) rules: earnings come out first and are taxable as ordinary income, and you do not reach your tax-free basis until all gains are withdrawn. For example, if you put $100,000 into a non-qualified annuity that has grown to $130,000 and withdraw $20,000, the full $20,000 is taxable because it comes from the $30,000 of earnings first. For qualified annuities (IRA, 403(b)), withdrawals are generally 100% taxable because the money went in pre-tax.

Once you annuitize a non-qualified contract, each payment is split between taxable earnings and tax-free basis using the exclusion ratio. The ratio is your investment in the contract divided by the total payments you are expected to receive.

• Example: you paid $90,000 and expect $120,000 in total payments, so the exclusion ratio is 75% ($90,000 ÷ $120,000).
• Each payment: 75% is a tax-free return of basis and 25% is taxable.
• After basis is recovered: once you have received your full $90,000 back, every later payment is fully taxable.

If you take a taxable distribution before age 59½, you may owe an additional 10% IRS penalty on top of regular income tax. Common exceptions include disability, death benefits paid to beneficiaries, and substantially equal periodic payments (72(t)). See a real example of how annuity withdrawals are taxed.

How Much of My Annuity Income Is Taxable?

It depends on how the annuity was funded. With today’s top quotes, here is what a 65-year-old man would owe tax on from a $100,000 immediate annuity:

• Monthly payment: about $701 for life, based on carrier quotes from October 2026.
• Non-qualified (after-tax savings): only about $285 of each check is taxable. The rest is your own money coming back, spread over the IRS’s 20-year expected payout for a 65-year-old (IRS Publication 939).
• Qualified (IRA or 401(k) rollover): the full $701 is taxable, because the money went in pre-tax.
• If you outlive your basis: on a non-qualified annuity, payments after about age 85 become fully taxable.

The insurer reports the taxable amount to you and the IRS each year on Form 1099-R. Run your own numbers with our immediate annuity calculator. To estimate the tax on a withdrawal, lump sum or income stream, use our annuity tax calculator.

Do Annuity Payments Count as Earned Income?

No. Annuity payments are taxed as ordinary income, but the IRS does not treat them as earned income.

• IRA contributions: you need taxable compensation, like wages, to contribute to an IRA, so annuity income alone does not qualify (IRS Publication 590-A).
• Social Security earnings test: annuity income does not count toward the limit that can reduce benefits for people who claim before full retirement age (SSA).
• Payroll taxes: annuity payments are not subject to Social Security or Medicare payroll tax.

Are Annuity Death Benefits Taxable?

When an annuity owner dies, the beneficiary owes ordinary income tax on the earnings portion of the death benefit. The original basis carries over, which means annuities do not receive a step-up in basis like stocks or mutual funds. Beneficiaries generally have a few payout options that affect the timing of that tax:

• Lump sum: all taxable gains are recognized in one year, which can push the beneficiary into a higher bracket.
• 5-year rule: distributions can be spread over five years to manage the tax impact.
• Lifetime payout: some contracts allow payments stretched over the beneficiary’s life expectancy.
• Spousal continuation: a surviving spouse can often continue the contract as the new owner and keep deferring taxes.

Are Inherited Annuities Taxable?

Yes, on the gains, not on the original after-tax principal. Non-qualified inherited annuities are taxed on earnings as they are distributed.

Qualified inherited annuities (IRAs, 403(b)s) follow inherited-IRA rules. Under the SECURE Act, most non-spouse beneficiaries must distribute the entire account within 10 years, and those distributions are generally fully taxable as ordinary income (IRS Publication 590-B).

How Are Non-Qualified Annuities Taxed?

Non-qualified annuities are bought with after-tax dollars outside a retirement account, so only the earnings above your basis are taxable.

• Growth: tax-deferred until you take money out.
• Withdrawals before annuitization: LIFO, so earnings come out first, then your tax-free basis.
• Annuitized payments: split by the exclusion ratio.
• Early withdrawals: the 10% penalty applies to taxable amounts taken before age 59½ unless an exception applies.

Fixed index annuities follow these same rules; see how fixed index annuities are taxed.

How Are Qualified Annuities Taxed?

Qualified annuities sit inside tax-advantaged retirement accounts and are funded with pre-tax or tax-deductible dollars, so distributions are generally fully taxable as ordinary income. A few specifics:

• Required minimum distributions (RMDs): starting at age 73 (75 if you were born in 1960 or later), you must take distributions from most qualified accounts or face a penalty on the shortfall.
• QLACs: a qualifying longevity annuity can delay RMDs on up to $210,000 of IRA money in 2026 (IRS Notice 2025-67).
• Roth annuities: held inside a Roth IRA, qualified distributions can be completely tax-free once you meet the 5-year and age requirements.
• Reporting: the insurer reports taxable amounts each year on Form 1099-R.

2026 Tax Changes That Affect Annuity Income

None of these change how an annuity itself is taxed. They change how much of your total income, annuity payments included, ends up taxable.

• New $6,000 senior deduction (2025 to 2028): each person 65 or older can deduct an extra $6,000, or $12,000 for a married couple who both qualify. It phases out above $75,000 of modified adjusted gross income ($150,000 joint), and you can take it whether or not you itemize (IRS).
• 2026 standard deduction: $16,100 single or $32,200 married filing jointly (IRS Bulletin 2025-45).
• Extra standard deduction at 65: $2,050 if single, or $1,650 for each married spouse 65 or older, on top of the amounts above.
• QLAC limit: stays at $210,000 for 2026.

Example: a married couple, both 65, could deduct $32,200 + $3,300 + $12,000 = $47,500 before any of their annuity, pension or IRA income is taxed, if their income is under the phase-out.

What Are the Best Tax Strategies for Annuity Owners?

• Time your withdrawals. Take non-qualified withdrawals in lower-income years to stay in a lower bracket.
• Annuitize for lifetime income. The exclusion ratio spreads the taxable portion over many years, smoothing your annual tax bill.
• Use a 1035 exchange. You can swap one non-qualified annuity for another tax-free under IRS Section 1035, preserving basis and deferring taxes (it postpones, it does not erase).
• Consider spousal continuation. A surviving spouse who continues the contract can defer taxes indefinitely.
• Watch the senior deduction phase-out. A large withdrawal in one year can push income over $75,000 ($150,000 joint) and shrink the new $6,000 deduction.
• Mind state taxes. Your state may tax annuity income too, so check the rules, especially if you have moved to a tax-friendly state.

For every rule in one place, including 1035 exchanges, RMDs and inherited contracts, see our full annuity taxes reference guide.

Are annuities taxable? Yes, but only the earnings and only when you take money out, so tax-deferred growth works in your favor. Compare today’s fixed annuity rates to see what top-rated carriers pay on tax-deferred MYGAs.

Frequently Asked Questions About Annuity Taxes

Are annuity payments taxable?

Non-qualified annuity payments are partly taxable and partly a tax-free return of your after-tax principal, based on the IRS exclusion ratio. Qualified annuity payments (from IRAs or 403(b)s) are generally fully taxable as ordinary income.

Are annuity withdrawals taxable?

Usually yes. Non-qualified withdrawals follow LIFO, so earnings come out first and are taxed as ordinary income until the gains are exhausted. Qualified withdrawals are generally fully taxable. Withdrawals before age 59½ may add a 10% IRS penalty on the taxable portion.

How much of my annuity income is taxable?

All of it if the annuity holds IRA or 401(k) money. If you bought it with after-tax savings, only the earnings part of each payment is taxable, and the rest is your own money coming back tax-free until you recover your full investment.

Do annuity payments count as earned income?

No. They are taxed as ordinary income but are not earned income, so they cannot fund an IRA contribution and do not count toward the Social Security earnings test.

Do annuities get a step-up in basis at death?

No. Unlike stocks, mutual funds, and real estate, annuities do not receive a step-up in basis when the owner dies. Beneficiaries inherit the original cost basis and owe ordinary income tax on any gains above it.

Can I avoid taxes on my annuity?

You can defer taxes with a 1035 exchange into another annuity or reduce the annual hit by annuitizing over your lifetime, and a Roth IRA annuity can provide tax-free qualified distributions. But you cannot eliminate taxes on the gains in a non-qualified or traditional qualified annuity.

What is the exclusion ratio?

The exclusion ratio is the percentage of each annuitized payment that is a tax-free return of basis versus taxable earnings. It equals your investment in the contract divided by the expected total payments. Once your basis is fully recovered, all remaining payments are fully taxable.

This guide is educational and not individualized tax advice; consult your tax professional for your situation.

Sources

• IRS Topic No. 410, Pensions and Annuities
• IRS Publication 575, Pension and Annuity Income
• IRS Publication 939, General Rule for Pensions and Annuities
• IRS Publication 590-B, Distributions from IRAs
• 26 U.S. Code § 72, Annuities
• IRS, Enhanced deduction for seniors
• IRS Internal Revenue Bulletin 2025-45 (2026 inflation adjustments)
• IRS Notice 2025-67 (2026 retirement plan limits)
• Social Security Administration, Receiving Benefits While Working