Annuities are classified into two basic types: tax-qualified and non-qualified,
depending whether the annuity was an IRA or held in an employer-sponsored plan or
purchased with after-tax dollars.
Tax-qualified annuities, such as some IRAs, are generally funded with pre-tax
dollars. This means taxes were not paid on the money before it was put into the
annuity. Therefore, state and federal income taxes are generally due on the entire
amount – both the initial paid premium and all increases in value –
when the money is taken out. Different rules apply to Roth IRAs which are tax-qualified but are purchase with after-tax dollars.
With a non-qualified annuity, income taxes were already paid on the money before it was
put into the annuity contract. Therefore, the money put into the non-qualified
annuity contract is not subject to taxes. However, any increase in value on that
money is taxable when it is received.