How Are Qualified Annuities Taxed? Withdrawals, Penalties, and RMDs

Qualified annuities are taxed as ordinary income when you take money out. Because you funded the annuity with pre-tax dollars inside a retirement account like a 401(k), 403(b), or traditional IRA, the IRS treats every dollar of every distribution as taxable. Federal rates for 2026 run from 10% to 37%, and withdrawals taken before age 59½ generally carry an extra 10% penalty. Once you hit your required beginning age, the IRS forces annual withdrawals whether you want them or not.

What Makes an Annuity Qualified

An annuity is qualified when it sits inside a tax-advantaged retirement account. The usual homes are employer-sponsored 401(k) and 403(b) plans, along with traditional IRAs, and they share the same core tax treatment. Contributions go in before federal income tax is calculated, which lowers your taxable income for that year. Investment gains inside the contract compound without being taxed annually, a deferral governed by Internal Revenue Code Section 72.¹

That deferral is the trade. You skip taxes going in and while the money grows; the IRS collects when you take it out. Every rule below flows from that arrangement.

How Withdrawals Are Taxed

Every withdrawal from a qualified annuity is ordinary income on your federal return. There is no splitting the payment into a taxable portion and a tax-free return of principal the way non-qualified annuities work. The IRS simplified method may allow a small tax-free portion only if you made after-tax contributions to the plan, but most participants funded entirely with pre-tax dollars and owe tax on the full amount.²

For 2026, federal income tax rates run from 10% on the first $12,400 of taxable income for single filers up to 37% on income above $640,600.³ Annuity distributions stack on top of any other income you earn that year, so a large single withdrawal can shove part of the money into a higher bracket. Retirees who can control the timing and size of withdrawals often spread them across several years to keep more of the income in lower brackets.

One planning move can strip a distribution out of taxable income entirely. If you are 70½ or older and the annuity is inside a traditional IRA, you can send up to $111,000 per year directly to a qualifying charity as a qualified charitable distribution. The transfer counts toward your required minimum distribution but is excluded from your taxable income.⁴ The check must go directly from the IRA custodian to the charity; if it passes through your hands, the exclusion is lost. QCDs are available only from IRAs, not from 401(k) or 403(b) accounts.

The 10% Early Withdrawal Penalty

Pulling money out before age 59½ triggers an extra 10% tax on top of the regular income tax. This additional tax is set by IRC Section 72(t) and applies across 401(k)s, 403(b)s, IRAs, and other qualified plans.¹ On a $50,000 early withdrawal for someone in the 22% bracket, the combined federal tax and penalty runs to roughly $16,000.

Congress has written several exceptions where the 10% penalty does not apply:

Total and permanent disability of the account owner.
Unreimbursed medical expenses above 7.5% of your adjusted gross income.
Substantially equal periodic payments, calculated over your life expectancy under Section 72(t), that continue for at least five years or until you reach 59½, whichever comes later.
Separation from service in or after the year you turn 55, for withdrawals from that specific employer’s plan. This does not apply to IRAs.
Distributions to an ex-spouse under a qualified domestic relations order.

The separation-from-service exception catches people off guard. It works only for the plan at the employer you left, and only if you were at least 55 when you separated. Roll that money into an IRA first, and the exception is gone.⁵

SECURE 2.0 added two more categories starting in 2024. Domestic abuse survivors can withdraw up to $10,000, or 50% of the account balance if smaller, without the 10% penalty. A separate provision allows one emergency personal-expense withdrawal per year of up to $1,000. Both still owe regular income tax; only the penalty is waived.⁵

Required Minimum Distributions

Tax-deferred money cannot sit indefinitely. Once you reach your required beginning age, you must pull out a minimum amount each year. The trigger age depends on your birth date:

Born before July 1, 1949: RMDs started at 70½.
Born July 1, 1949 through December 31, 1959: RMDs begin at 73.
Born January 1, 1960 or later: RMDs begin at 75.

SECURE 2.0 created a drafting ambiguity for people born in 1959, and the IRS resolved it in proposed regulations: if you were born in 1959, your RMD age is 73.⁶

Your first RMD can be delayed until April 1 of the year after you hit the trigger age, but doing so means taking two RMDs in one calendar year, which can push you into a higher bracket. After that first year, each RMD is due by December 31. The amount is your prior-year December 31 balance divided by a life expectancy factor from IRS tables. Most people use the Uniform Lifetime Table; if your sole beneficiary is a spouse more than ten years younger, the Joint Life and Last Survivor Expectancy Table produces a smaller required withdrawal.⁷

If you own several IRAs, calculate each RMD separately but take the combined total from whichever IRA you pick. The same flexibility applies across 403(b) accounts. Each 401(k), on the other hand, stands alone: its RMD has to come out of that specific plan, and you cannot cover it by pulling from an IRA or another 401(k).⁸

Missing an RMD is expensive. The excise tax is 25% of the amount you should have withdrawn but did not. It drops to 10% if you take the missed amount and file a corrected return within the correction window, which generally runs through the end of the second tax year after the year the penalty was imposed.⁹ Report shortfalls on Form 5329.¹⁰

Rollovers Without Triggering Tax

Moving qualified annuity money between accounts is routine when you change jobs or consolidate. Whether the move triggers tax depends entirely on how the transfer happens.

In a direct rollover, sometimes called a trustee-to-trustee transfer, the money moves from one plan to another without you ever taking possession. No withholding, no penalty, and the full balance keeps growing tax-deferred. This is the option the IRS clearly prefers.

If the distribution comes to you instead, the plan administrator must withhold 20% for federal income tax before writing the check.¹¹ You then have 60 days to deposit the full original amount, including making up the withheld 20% out of pocket, into another eligible retirement account. Miss that deadline and the entire distribution becomes taxable income. If you are under 59½, the 10% early withdrawal penalty applies too.¹²

Here is where most rollover mistakes happen. Say your plan distributes $100,000. The administrator sends you $80,000 after withholding $20,000. To complete the rollover tax-free, you need to deposit $100,000 in the new account within 60 days, which means finding $20,000 from other funds. You get the withheld amount back when you file your return, but only if the rollover was actually completed. Deposit just the $80,000, and the missing $20,000 is treated as a taxable distribution.

One more trap for IRA owners: indirect IRA-to-IRA rollovers are limited to one per 12-month period across all your IRAs combined. The limit does not apply to direct rollovers, Roth conversions, or rollovers between employer plans and IRAs.¹²

Taxation When Someone Inherits the Annuity

Death does not erase the tax. Beneficiaries owe ordinary income tax on distributions from an inherited qualified annuity, the same way the original owner would have. How fast the money has to come out depends on who inherits.

A surviving spouse has the most flexibility. They can roll the annuity into their own IRA and treat it as their own account, deferring taxes until they reach their own RMD age. Or they can keep it as an inherited account and take distributions based on their own life expectancy.¹³

Most non-spouse beneficiaries who inherited after 2019 must empty the account by the end of the tenth year following the owner’s death. There is no annual minimum during those ten years, but the full balance has to be distributed and taxed by the deadline. Taking it all in year ten concentrates the tax hit; spreading withdrawals gives more control over which bracket the income lands in.¹³

A narrow group of eligible designated beneficiaries can still stretch distributions over their own life expectancy instead of following the 10-year rule:

Minor children of the deceased, until they reach the age of majority; then the 10-year clock starts.
Disabled or chronically ill individuals.
Beneficiaries no more than 10 years younger than the deceased owner.

Adult children, siblings more than 10 years younger, and non-individual beneficiaries like estates and most trusts do not qualify and must follow the 10-year rule.¹³

State Income Tax on Distributions

Federal tax is not the whole picture. Most states with an income tax treat qualified annuity distributions as taxable income, the same way the IRS does. State rates range from zero in states with no income tax to over 13% at the top. Many states offer partial exemptions for retirement income, but the thresholds, age requirements, and qualifying income types vary widely. Some exempt a flat dollar amount; others phase the exemption out above certain income levels. If retirement might involve a move, check the destination state’s treatment of retirement plan distributions before you go.

1
Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
2
Internal Revenue Service. Topic No. 411, Pensions – The General Rule and the Simplified Method
3
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026, Including Amendments From the One, Big, Beautiful Bill
4
Internal Revenue Service. Cost-of-Living Adjusted Limitations for 2026 Notice 2025-67
5
Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
6
Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs
7
Internal Revenue Service. Retirement Topics – Required Minimum Distributions (RMDs)
8
Internal Revenue Service. RMD Comparison Chart (IRAs vs. Defined Contribution Plans)
9
Office of the Law Revision Counsel. 26 USC 4974 – Excise Tax on Certain Accumulations in Qualified Retirement Plans
10
Internal Revenue Service. Instructions for Form 5329
11
eCFR. 26 CFR 31.3405(c)-1 – Withholding on Eligible Rollover Distributions; Questions and Answers
12
Internal Revenue Service. Rollovers of Retirement Plan and IRA Distributions
13
Internal Revenue Service. Retirement Topics – Beneficiary