Understanding Annuities: How are Indexed Annuities Taxed?
During the Accumulation Phase:
Earnings credited on the funds in an indexed annuity are tax deferred,
meaning that the earnings are not taxed while they remain in the annuity.
Withdrawals from an indexed annuity during the accumulation phase are
treated as withdrawals of earnings to the extent that the cash value of the
annuity exceeds the total premiums paid and are taxed as income in the year
withdrawn. To the extent that a withdrawal exceeds any earnings, that
portion of the withdrawal is considered a non-taxable return of principal.
In addition, a 10% penalty tax may be imposed on withdrawals made before
age 59-1/2, unless certain conditions are met. The penalty tax is in addition
to the regular income tax on the withdrawal.
If the annuitant dies during the accumulation phase, the death benefit of the
indexed annuity is generally included in the annuitant’s estate, to the extent
of the deceased annuitant’s proportional contribution to the annuity purchase
During the Income Phase:
The annuity purchase price is returned in equal income-tax-free amounts over
the expected payment period (based on the annuitant’s life expectancy).
The portion of each payment in excess of the tax-free return of the purchase
price is taxable in the year received.
In summary, a portion of each annuity payment is received income tax free
and the balance is taxable as received.
At the annuitant’s death, the present value of any remaining annuity
payments due is generally included in the annuitant’s estate, to the extent of
the deceased annuitant’s proportional contribution to the annuity purchase
A professional tax advisor should be consulted for more detailed
information on annuity taxation in your situation.