All monthly payments are taxed as ordinary income. If the annuity is a qualified plan, all of the monthly income payments will be subject to taxes. Only the interest will be taxed if the annuity is a non-qualified plan. If the annuity is a Roth IRA, payments will be tax-free.
Taxes On Monthly Life Annuity Benefit Payments
| Qualified Annuity | Roth Annuity | Non-Qualified Annuity | |
|---|---|---|---|
| Funded With | Pre-taxed Money | After-Tax Money | After-Tax Money |
| Withdrawals | 100% Taxable | Tax-Free | Interest-Only Taxed (LIFO) |
| Annuitized Payments | 100% Taxable | Tax-Free | Exclusion Ratio |
| RMDs | Yes at Age 73 | No | No |
| Contribution Limit | Yes | Yes | No |
Qualified Annuity Benefit Payments
All monthly withdrawals and payments from a qualified annuity (IRA Annuity) are taxed as regular income. All withdrawals from a Roth IRA Annuity are income tax-free.
Non-Qualified Annuity Benefit Withdrawals
There are no taxes on the principal when money is taken via a penalty-free withdrawal or lifetime withdrawals from a non-qualified annuity. Owners have to pay taxes only if there are earnings and interest. You will follow the “last-in-first-out” (LIFO) protocol of the IRS if it’s a non-qualified annuity withdrawal.
Last-In-First-Out (LIFO) means any taxable earnings and interest is distributed to the annuity holder first. Once the interest and earnings are depleted, there are no taxes due.
- Traditional Withdrawals = Last-In, First-Out
- Penalty-Free Withdrawals = Last-In, First-Out
- Lifetime Income Payments (Income Rider) = Last-In, First-Out
Non-Qualified Annuity Benefit Annuitized Payments
The IRS calculates how much of an annuitized annuity withdrawal is taxable. This calculation is called the exclusion ratio. This ratio calculation is based on the length of the annuity, the principal, and the earnings.
If a non-qualified annuity is set up to pay the owner annuitized annuity payments for their entire life, the exclusion ratio will consider their life expectancy. If they live longer than their calculated life expectancy, all annuity payments beyond that time period are taxed as income.
- Annuitized Annuity Payments = Exclusion Ratio
- Structured Settlements
- Single-Premium Immediate Annuities (SPIA)
- Non-Qualified Longevity Annuities