How are annuity earnings taxed?

• A. Earnings portion taxed as ordinary income when withdrawn; tax depends on cost basis.
• B. Earnings taxed as capital gains when withdrawn.
• C. Earnings are tax-free.
• D. Earnings taxed as corporate income.

Answer: (A)

Annuity earnings grow tax-deferred until you take distributions, and when you withdraw, only the earnings portion is taxed as ordinary income at your current tax rate. The portion that represents your cost basis—the premiums you paid—comes back tax-free. So the tax on withdrawals hinges on how much of the distribution is earnings versus basis, not capital gains treatment. This reflects why the earnings are taxed as ordinary income, not as capital gains, and why the withdrawal isn’t tax-free or taxed as corporate income. If the annuity was funded with pre-tax dollars (a qualified annuity), then all withdrawals are taxed as ordinary income. An early withdrawal may also trigger an additional 10% penalty on the taxable amount if taken before age 59½.