Watch Out for Withdrawals and Income Payments, Which Are Taxed!
It’s all well and good when an annuity’s growth is not taxes. But watch out, your withdrawals and payments will be. Gains and interest credits from all types of annuities are taxed as ordinary income. They’re taxed on a LIFO basis (Last In, First Out). This means that accumulated interest earnings are considered to be withdrawn first before any tax-free principal.
Keep this disadvantage in mind and aim to extend your tax benefits by converting it an immediate income annuity or a deferred income annuity. In these cases, monthly payments include taxable interest and tax-free return of principal.
Seniors who live past their life expectancy and get their principal back will notice that payments will become fully taxable, so keep that in mind too!