An annuity is typically part of a retirement investment.
You aren’t taxed on the interest your money earns while it stays in the annuity.
You must pay taxes on earned income when it is paid to you.
An advantage of tax deferral is that the tax bracket you’re in when you receive annuity income payments (usually during retirement) may be lower than the one you’re in during the accumulation period.
You’ll also be earning interest on the amount you would have paid in taxes during the accumulation period.
Part of the payments you receive from an annuity will be considered as a return on the premium you’ve paid.
You won’t have to pay taxes on that part.
Another part of the payments is considered interest you’ve earned.
You must pay taxes on the part that is considered interest when you withdraw the money.
You may also have to pay a 10% tax penalty if you withdraw the accumulation before age 59½.
The Internal Revenue Code also has rules about distributions after the death of a contract holder.
Annuities used to fund certain employee pension benefit plans defer taxes on plan contributions as well as on interest or investment income. (Those under Internal Revenue Code Sections 401(a), 401(k), 403(b), 457 or 414 -- you can look them up here.)
Within the limits set by the law, you can use pretax dollars to make payments to the annuity. When you take money out, it will be taxed.
If you buy an annuity to fund an IRA, you’ll receive a disclosure statement describing the tax treatment.
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