For many seniors, annuities are a great way to add up to your retirement savings. But they can also be tricky. On one hand, it’s not the whole amount that is taxable by the time you reach retirement age. To be more exact, your principal is tax-free, but you’d still have to pay taxes on your earned interest.
A simple example would look like this: if you purchased an annuity for $100,000 that will be worth $150,000 by the time you retire, you should expect to pay taxes on the $50,000 difference (earned interest).
On the other hand, annuities bought with pretax funds will be fully taxed.
Another caveat you should be aware of and prepare for is the fact that you won’t have to pay at the preferable capital gains rate. Instead, you’ll pay taxes at your ordinary income tax rate. Make sure you discuss all the details with the financial institution that sold your annuity.