If you’re comparing annuities and stocks for retirement, one of the biggest questions is: How are annuity payouts taxed compared to stocks?
The answer matters because stocks and annuities can receive very different federal tax treatment. A taxable brokerage account may generate capital gains, while the taxable earnings distributed from an annuity are generally treated as ordinary income.
That does not automatically make one better than the other. But it does mean you need to understand the tax rules before moving a large amount of retirement money.
I’ve seen people focus entirely on the payout rate, growth potential, or guarantee and barely think about taxes until later. In my opinion, that is a mistake.
So, let’s walk through how stocks are taxed, how nonqualified annuities are taxed, and what can happen when you use an annuity for lifetime retirement income.
Need help choosing the best annuity for your unique situation? Have questions about getting an annuity? If so, it’s best to speak with an annuity specialist. Watch this short video to see how I can help you do this (at no cost to you!)
Tip: See how much an annuity could pay you using my annuity calculator
What Is the Main Tax Difference Between Annuities and Stocks?
Here is the basic difference.
With a regular taxable brokerage account, selling stock for a profit can create a capital gain. Whether that gain is short-term or long-term generally depends on how long you held the asset.
The IRS generally treats a gain on an asset held for more than one year as long-term and a gain on an asset held for one year or less as short-term.
With a nonqualified annuity, the taxable earnings you receive generally do not get long-term capital-gains treatment simply because the money stayed in the contract for years. The taxable portion of an annuity distribution is generally treated as ordinary income.
That is one of the first things I want people to understand.
Buying an annuity does not turn the contract’s gains into capital gains.
At the same time, an annuity may provide something a stock account does not automatically provide: tax deferral on internal earnings and, depending on the contract, contractual guarantees such as lifetime income.
So, this is not simply a question of:
“Which one has the lower tax rate?”
The better question is:
“What am I trying to accomplish with this money?”
💡 Pro Tip: Never compare an annuity and a stock portfolio based only on gross returns. Compare taxes, liquidity, guarantees, income, risk, fees, and what happens if you live much longer than expected.
How Are Stock Gains Taxed in a Brokerage Account?
Let’s say you have a regular nonqualified brokerage account.
You earned the money, paid taxes on it, and then invested that after-tax money in stocks. If those stocks increase in value and you later sell them for more than your tax basis, you may realize a capital gain.
Generally:
- Held one year or less: the gain is short-term.
- Held more than one year: the gain is long-term.
The IRS makes this holding-period distinction when classifying capital gains and losses.
That distinction can be important because long-term capital gains may receive different federal tax treatment than ordinary income, while short-term gains are generally taxed at ordinary income-tax rates.
But stocks can create other taxable income too.
For example, dividends may be taxable even when you do not sell your shares. And frequent buying and selling can create realized gains along the way.
So I would never say, “Stocks are always taxed at capital-gains rates.”
That is too simplistic.
The actual answer depends on what kind of income you receive, how long you held the investment, whether you sold it, your tax bracket, and other factors.
👉 Thinking about moving part of a brokerage account into an annuity for guaranteed retirement income? Schedule a call with me and let’s compare the options before you make the move.
How Are Nonqualified Annuity Payouts Taxed?
This is where people often get confused.
A nonqualified annuity is generally funded with after-tax money. In simple terms, you have already paid income tax on the principal you contributed.
That original after-tax amount is generally your investment in the contract, often called your basis or cost basis.
The earnings are different.
The IRS states that annuity earnings generally are not taxed until they are distributed through withdrawals or annuity payments, and the taxable portion is treated as ordinary income.
But here is the critical part:
Not every annuity payout is taxed the same way.
Withdrawals before true annuitization
For many nonqualified annuity distributions that are not received as annuity payments, the general federal rule is income-first treatment.
You may hear this called LIFO, or “last in, first out.”
In plain English, that generally means the gain comes out before your original after-tax principal.
The IRS gives an example in Publication 575 where a pre-annuity-starting-date distribution is allocated first to earnings, with the remaining portion treated as a tax-free return of investment in the contract.
Actual annuitization can work differently
This distinction is extremely important.
When a nonqualified contract is actually converted into a stream of annuity payments, the tax calculation may allow each payment to contain both:
- A tax-free return of your investment in the contract
- A taxable portion
The IRS General Rule is used for certain nonqualified annuity payments, and the IRS describes these monthly payments as generally consisting of a tax-free return of net cost plus a taxable balance.
So I want to be very clear:
A withdrawal from a deferred indexed annuity and a payment from a contract that has been formally annuitized are not automatically taxed the same way.
This matters when comparing:
- An indexed annuity with a lifetime income rider
- A fixed deferred annuity (DIA) – annuitized
- A MYGA
- A single premium immediate annuity, or SPIA – annuitized
- Other annuity structures
💡 Pro Tip: Before buying an annuity, ask exactly how the income will be produced. “Lifetime income” does not by itself tell you whether the payments are withdrawals under a rider or true annuity payments for federal tax purposes.
4. What Does a $450,000 Annuity Tax Example Look Like?
Let’s use an example similar to one I walked through in my video.
Suppose someone in Illinois has $450,000 and wants to begin retirement income at age 68.
In the example I reviewed, the highest illustrated annual lifetime payout was roughly $46,953, with other options coming in somewhat below that amount.
The exact payout available to you can change based on:
- Your age
- Your state
- Whether income covers one life or two
- The carrier
- The contract
- The income start date
- Available features
- Current pricing
That is why I compare multiple carriers instead of assuming one company is automatically best.
Now, let’s assume the $450,000 is nonqualified after-tax money placed into a deferred annuity, and the retirement income is being produced through withdrawals rather than formal annuitization.
Scenario A: There are no earnings left in the contract
Imagine the contract has no gain when a withdrawal is taken.
In that situation, there may be no untaxed earnings to distribute first. A withdrawal can therefore represent a return of your after-tax basis, subject to the specific contract and tax rules.
That return of basis is not taxed again because it represents money that was already taxed before going into the annuity.
Eventually, however, you will recover all of your basis.
Once your investment in the contract has been fully recovered, later taxable distributions will be fully taxable as ordinary income. The IRS notes that annuity payments can be fully taxable when the taxpayer has no remaining investment in the contract, including when after-tax contributions have already been recovered tax-free.
Scenario B: The annuity has earnings
Now imagine the $450,000 grows to approximately $481,000 before income begins.
That means there is roughly $31,000 of gain in the contract.
Under the general income-first rule for a nonqualified distribution that is not received as an annuity, that gain may come out first. So, using this simplified example, roughly the first $31,000 distributed could be taxable as ordinary income before additional amounts represent a return of basis.
Suppose the annual income is approximately $47,000.
In a simplified illustration:
- Roughly $31,000 could represent taxable gain.
- The remaining portion could represent a return of after-tax basis.
Then, in a later year, perhaps the contract earns another $9,000 before the relevant distribution cycle.
Depending on the contract values and tax rules, you will have another mix of:
- Taxable earnings
- Tax-free return of basis
That is why a nonqualified annuity distribution is not always “100% taxable” or “100% tax-free.”
The answer can change over time.
And again, I want to emphasize that formal annuitization uses a different tax calculation, so the exact payment structure matters.
👉 Want help seeing how a real annuity might pay based on your age, state, deposit, and income goal? Schedule a call with me and I’ll walk you through the options.
5. How Are MYGA Taxes Different From Stocks and CDs?
Now let’s look at a different type of annuity.
A MYGA, or multi-year guaranteed annuity, is commonly used by people who want a contractually stated interest rate for a specific period.
You might look at a:
- 3-year MYGA
- 5-year MYGA
- 7-year MYGA
- 10-year MYGA
Rates change, so I do not recommend choosing one based on an old article, old video, or screenshot. You need to look at what is actually available when you are ready to make a decision.
The potential tax advantage is tax deferral.
Inside a nonqualified annuity, earnings generally are not taxed until distributed through a withdrawal or annuity payment. The taxable portion is generally treated as ordinary income.
Compare that with a typical bank CD.
Most taxable interest is generally included in taxable income when it becomes available to you, subject to the applicable rules. The IRS treats CD interest as interest income rather than capital gain.
That last point is worth emphasizing because I do not want anyone to misunderstand the comparison:
Regular CD interest is generally not capital-gains income.
It is generally taxable interest income.
So, in broad terms:
- Taxable brokerage account: selling appreciated stock can trigger capital gains.
- CD: interest is generally taxable interest income as it becomes reportable.
- Nonqualified MYGA: earnings generally grow tax-deferred until distributed, with the taxable portion generally treated as ordinary income.
That tax deferral can be valuable for certain people.
You may also be able to exchange one annuity contract for another under Section 1035 without immediately recognizing gain when all applicable requirements are satisfied. But this needs to be structured properly; simply cashing out an old nonqualified annuity and personally moving the money to a new one is not automatically a tax-free exchange.
💡 Pro Tip: Do not casually “roll over” a nonqualified annuity by taking possession of the money first. Have the transaction reviewed and structured correctly because the method of transfer can affect taxation.
Conclusion
From a pure tax-rate perspective, a taxable stock account can have an advantage when you realize qualifying long-term capital gains.
But taxes are only one part of retirement income planning.
An annuity may offer features such as:
- Tax-deferred accumulation
- Contractual lifetime income
- Principal-protection features on certain contracts
- Reduced exposure to direct market losses with certain fixed or fixed indexed annuities
- The ability to transfer longevity risk to an insurance company
Stocks may offer:
- Greater liquidity
- Higher long-term growth potential
- Long-term capital-gains treatment when applicable
- More control over when gains are realized
- No annuity surrender schedule
So, what is better?
It depends on the job you need the money to do.
If your main objective is maximum long-term growth and liquidity, an annuity may not be the best home for all of your money.
If your goal is creating a contractual lifetime income floor that continues no matter how long you live, an annuity may deserve serious consideration.
Need help with finding the best annuity for your retirement?
Click here to schedule a call with me.
On the call, I can help you:
- Determine what type of annuity is best for you
- Find the highest paying annuities for your unique situation
- Answer any other questions you may have