Yes, you generally pay taxes on annuity income, and in most cases the payments are taxed as ordinary income at your regular federal rate. How much of each payment is taxable depends on how the annuity was funded. If you bought it with pre-tax money inside a 401(k), 403(b), or traditional IRA, every dollar you withdraw is taxable. If you bought it with money that was already taxed, only the earnings portion is taxable and part of each payment comes back to you tax-free. Withdrawing before age 59½ adds a 10% penalty on top of the tax you already owe.
Qualified Annuities: Every Dollar Is Taxable
A qualified annuity sits inside a tax-advantaged retirement account. Because every contribution reduced your taxable income the year you made it, neither the principal nor the growth has been taxed yet. The IRS treats the full amount of every distribution as ordinary income.1Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts There is no tax-free portion to recover because you already got the tax break up front.
For 2026, federal ordinary-income rates for single filers run 10% on the first $12,400, 12% up to $50,400, 22% up to $105,700, 24% up to $201,775, 32% up to $256,225, 35% up to $640,600, and 37% above that. Joint filers get roughly double those thresholds.2Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Each annuity payment stacks on top of your other income for the year, so a large withdrawal can push you into a higher bracket.
The payer must withhold federal income tax from periodic payments as if they were wages unless you file Form W-4P with a different election.3Internal Revenue Service. Publication 575 – Pension and Annuity Income If you opt out or under-withhold, quarterly estimated payments may be needed to avoid an underpayment penalty.
Non-Qualified Annuities: Only the Earnings Are Taxed
A non-qualified annuity was purchased with after-tax dollars outside any retirement plan. The IRS will not tax that original investment twice. It uses an exclusion ratio to split each payment into a tax-free return of your principal and a taxable earnings portion.4Internal Revenue Service. Publication 939 – General Rule for Pensions and Annuities Only the earnings piece is taxed as ordinary income.
Divide your total investment by the expected return over the life of the contract to get the tax-free percentage of each payment. If you invested $10,800 into an annuity expected to pay a total of $24,000, the exclusion ratio is 45%. Out of a $1,200 annual payment, $540 comes back tax-free and $660 is taxable.4Internal Revenue Service. Publication 939 – General Rule for Pensions and Annuities Once you have recovered your entire original investment through those tax-free portions, every dollar after that is fully taxable.
The 3.8% Net Investment Income Tax
High earners face an additional 3.8% surtax on non-qualified annuity earnings. This net investment income tax applies when modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly), and it hits the lesser of your net investment income or the amount above the threshold. Distributions from qualified plans, including traditional and Roth IRAs, are specifically excluded from this surtax.5Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax
Roth Annuities Can Come Out Tax-Free
An annuity held inside a Roth IRA flips the picture. Contributions went in with after-tax dollars and no deduction was taken, so qualified distributions come out completely tax-free, earnings included. To qualify, the Roth IRA must have been open at least five years and you must be at least 59½ at the time of the distribution. Meet both conditions and you owe nothing on the withdrawal.
Roth annuities carry two other advantages. They are exempt from required minimum distributions during the original owner’s lifetime, and their distributions are excluded from the 3.8% net investment income tax. For someone expecting a high tax bracket in retirement, the Roth wrapper removes a layer of taxation that both qualified and non-qualified annuities would otherwise trigger.
Taking Money Out Before 59½
Withdrawing from an annuity before age 59½ adds a 10% additional tax on the taxable portion of the withdrawal, sitting on top of the ordinary income tax you already owe.1Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts The combined hit can consume a third or more of the money you pull out.
Non-qualified annuities get a further twist. The IRS applies an earnings-first rule: the first dollars you take out are treated as taxable earnings rather than a return of principal.3Internal Revenue Service. Publication 575 – Pension and Annuity Income You cannot claim you are simply pulling out your own after-tax money to sidestep the penalty. Every dollar of accumulated gain must come out and be taxed before you touch tax-free principal.
Exceptions to the 10% Penalty
Both qualified and non-qualified annuities allow penalty-free withdrawals after the owner’s death, upon total and permanent disability, and through substantially equal periodic payments.6Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions Qualified annuities inside employer plans share the broader list of exceptions available to 401(k) and IRA distributions, including certain medical expenses and qualified birth or adoption expenses. Non-qualified annuities have a narrower list.
A SEPP plan lets you tap an annuity before 59½ without the penalty, but the rules are strict. You must take a fixed series of payments calculated over your life expectancy (or the joint expectancy of you and a beneficiary), and the payments must continue for at least five years or until you reach 59½, whichever comes later.7Internal Revenue Service. Substantially Equal Periodic Payments Change the amount or stop early and the IRS retroactively imposes the 10% penalty on every distribution you took, plus interest.
Required Minimum Distributions at Age 73
If your annuity is inside a qualified plan or traditional IRA, required minimum distributions begin at age 73. The age rose from 72 under the SECURE 2.0 Act and is scheduled to rise to 75 starting in 2033. You can delay your first RMD until April 1 of the year after you turn 73, but waiting forces two distributions into one tax year, which can push you into a higher bracket.
Missing an RMD is one of the most expensive mistakes in the tax code. The IRS charges a 25% excise tax on the amount you should have withdrawn but did not.8Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs Catch the mistake and take the missed distribution within two years and the penalty drops to 10%. Either way, you report the shortfall on Form 5329. Non-qualified annuities and Roth IRAs are not subject to RMDs during the original owner’s lifetime.
Taxes on an Inherited Annuity
When an annuity owner dies, the remaining value passes to a beneficiary. Annuities do not receive a stepped-up basis at death. The beneficiary owes income tax on the difference between the death benefit and the original owner’s investment in the contract. Taking the entire amount as a lump sum forces all of that gain into a single tax year, which often creates a much larger bill than spreading payments out.
A surviving spouse has the most flexibility. For qualified annuities, the spouse can roll the distribution into their own IRA or retirement plan as if they were the original employee.3Internal Revenue Service. Publication 575 – Pension and Annuity Income For non-qualified annuities, many contracts let the spouse continue the contract entirely and keep using the same exclusion ratio.4Internal Revenue Service. Publication 939 – General Rule for Pensions and Annuities
Non-spouse beneficiaries have narrower choices. Under the SECURE Act, most designated beneficiaries must empty an inherited qualified annuity or retirement account by the end of the tenth year following the owner’s death.9Internal Revenue Service. Retirement Topics – Beneficiary A few “eligible designated beneficiaries” can still stretch distributions over their own life expectancy: minor children of the deceased (until they reach the age of majority, at which point the 10-year clock starts), disabled or chronically ill individuals, and anyone not more than 10 years younger than the deceased owner. For non-qualified annuities, the insurance contract typically requires distributions within five years or as a life annuity.
How Annuity Income Affects Social Security and Medicare
An annuity payment can drag other income into the tax base. Taxable annuity distributions count toward the modified adjusted gross income figure that determines whether Social Security benefits are taxed. Above $25,000 (single) or $32,000 (joint), up to 50% of your benefits become taxable. Above $34,000 (single) or $44,000 (joint), the taxable share rises to 85%.10Office of the Law Revision Counsel. 26 USC 86 – Social Security and Tier 1 Railroad Retirement Benefits These thresholds have never been adjusted for inflation.
Annuity income also feeds the income-related monthly adjustment amount (IRMAA) that sets your Medicare Part B and Part D premiums. For 2026, a single filer whose modified adjusted gross income exceeds $109,000 ($218,000 joint) pays a higher Part B premium starting at $284.10 per month instead of the standard $202.90. At the top tier, above $500,000 for single filers, the monthly premium reaches $689.90.11Centers for Medicare & Medicaid Services. 2026 Medicare Parts A and B Premiums and Deductibles A single large distribution can push you over an IRMAA threshold, and because IRMAA looks at income from two years prior, the higher premium arrives long after the withdrawal.
Reporting Annuity Income
Every year you receive a distribution, the insurance company or plan administrator sends Form 1099-R showing the total distribution, the taxable amount, and any federal or state tax withheld.12Internal Revenue Service. About Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, Etc. You report those figures on Form 1040 even if most of the distribution is tax-free. The IRS receives its own copy, so a mismatch on your return will generate a notice.
For periodic payments, use Form W-4P to set your withholding. Skip it and the payer withholds as if you are a single filer with no adjustments, which is often more than needed.13Internal Revenue Service. 2026 Form W-4P – Withholding Certificate for Periodic Pension or Annuity Payments For lump-sum or other non-periodic distributions, use Form W-4R. The default withholding on non-periodic payments is 10%, and on eligible rollover distributions it is 20%.14Internal Revenue Service. 2026 Form W-4R – Withholding Certificate for Nonperiodic Payments and Eligible Rollover Distributions Withholding is only an estimate; if your total income exceeds what the withholding assumed, you will owe the difference at filing.