How Annuity Withdrawals Are Taxed: What Every Retiree Should Know

Tax treatment is one of the biggest factors that separates annuities from other savings vehicles — and it is frequently misunderstood. This guide covers the key tax rules for MYGA and FIA withdrawals so you can plan more effectively.

The Core Principle: Tax-Deferred Growth

Both MYGAs and FIAs grow tax-deferred. You do not owe income tax on earned interest or credited gains while the money stays inside the annuity. This advantage compounds meaningfully over time compared to taxable accounts like CDs, where you pay taxes on gains each year regardless of whether you have made a withdrawal.

Qualified vs. Non-Qualified Annuities

The tax treatment of withdrawals depends on whether your annuity is qualified or non-qualified. Qualified annuities are funded with pre-tax dollars from a 401(k) or traditional IRA rollover. Non-qualified annuities are funded with after-tax money you have already paid income tax on.

LIFO: Last In, First Out

For non-qualified annuities, the IRS applies a LIFO rule — your accumulated gains are considered withdrawn first and are immediately taxable. Once gains are fully withdrawn, subsequent amounts are a return of principal and tax-free. This front-loads tax liability in the early years of withdrawals.

The 10% Early Withdrawal Penalty

Annuity withdrawals before age 59½ are generally subject to a 10% IRS penalty on top of ordinary income tax — identical to the rule that applies to IRA and 401(k) withdrawals. Exceptions exist for certain disability situations. As a general rule, annuities are not appropriate for money you might realistically need before retirement age.

Required Minimum Distributions

Annuities held inside a qualified account (IRA, 401k rollover) are subject to Required Minimum Distribution rules starting at age 73. Non-qualified annuities outside a retirement account are generally not subject to RMDs during accumulation. Knowing which type you have is essential for income planning.