Annuity taxation is the set of rules governing how annuity contributions, earnings, and distributions are treated for income-tax purposes. For nonqualified annuities, contributions are made with after-tax dollars, earnings grow tax deferred, and withdrawals are taxed as ordinary income on a LIFO basis until gains are exhausted. For qualified annuities held in IRAs or retirement plans, distributions are generally fully taxable, and required minimum distributions apply under IRS rules and the SECURE Act. Annuitized payments from nonqualified contracts use an exclusion ratio to separate taxable earnings from tax-free return of basis. Early distributions before age 5912 may incur additional 10 percent penalties, subject to exceptions.

Advisors explain annuity taxation when clients consider funding options, withdrawal strategies, or beneficiary designations. They coordinate with CPAs to determine the most tax-efficient sequence of distributions from annuities and other accounts. Advisors use carrier materials and Form 1099-R to clarify how much of each payment is taxable and what codes apply. In planning, they may recommend placing tax-inefficient assets like bonds inside annuities to benefit from deferral, while keeping more tax-efficient holdings outside. Understanding annuity taxation enables advisors to anticipate client questions at tax time, avoid surprises, and integrate annuities thoughtfully into long-term tax planning.