Annuity payments count as income on your tax return, but the amount you report depends on whether you bought the annuity with pre-tax or after-tax money

When you receive annuity payments, the IRS treats them as income. However, you do not report the entire payment amount. Instead, you report only the portion that represents earnings — the money your annuity contract actually made. The portion that represents your original investment (called your cost basis) is not taxed again, because you already paid taxes on it when you earned it.

The exact calculation depends on how you funded the annuity. If you bought it with money from a 401(k) or traditional IRA, the entire payment is taxable income. If you bought it with money you had already paid taxes on, only the earnings portion is taxable. Your annuity provider sends you a Form 1099-R each year showing how much of your payment is taxable.

Key Takeaways

  • Annuity payments are reported as income on your tax return, but only the earnings portion is taxable if you funded the annuity with after-tax money.
  • If your annuity came from a 401(k), traditional IRA, or other pre-tax retirement account, the entire payment is taxable income.
  • Your annuity company sends Form 1099-R each year, which shows the taxable amount you must report on your return.
  • The IRS uses an exclusion ratio to calculate how much of each payment is your original investment versus earnings.

How the IRS calculates what portion of your annuity is taxable

The IRS uses a formula called the exclusion ratio to determine what part of each annuity payment you report as income. The exclusion ratio compares your total investment in the annuity to the total amount you expect to receive over your lifetime.

Here is how it works in practice: suppose you invested $100,000 in an annuity that will pay you $500 per month for life. The IRS calculates how much you will receive in total over your expected lifespan (based on IRS life expectancy tables). If the total expected payout is $200,000, your exclusion ratio is $100,000 divided by $200,000, or 50 percent. This means 50 percent of each $500 payment ($250) is your original investment and not taxable. The other 50 percent ($250) is earnings and is taxable.

Once the IRS calculates your exclusion ratio, it stays the same for the life of the annuity. Your annuity provider does this calculation and reports it on your Form 1099-R, so you do not have to do the math yourself.

Annuities funded with pre-tax retirement account money

If you bought your annuity by rolling over money from a 401(k), traditional IRA, SEP-IRA, or straightforward IRA, the entire annuity payment is taxable income. There is no exclusion ratio and no cost basis to recover tax-free. This is because you never paid income tax on that money when you first earned it — the tax was deferred until you withdrew it.

These annuities are reported on Form 1099-R with a code that indicates the entire distribution is taxable. You report the full amount shown on the form on your tax return. If you are under age 59½ when you start receiving payments, you may also owe a 10 percent early withdrawal penalty on top of the income tax, unless an exception applies.

Annuities funded with after-tax money

If you purchased an annuity with money you had already paid income tax on — for example, money from a savings account or a non-may have access to investment account — only the earnings portion is taxable. Your original investment is recovered tax-free using the exclusion ratio described above.

These annuities are sometimes called non-may have access to annuities because they were not purchased through a tax-may have access to retirement plan. The Form 1099-R will show both the total payment and the taxable portion, calculated using your exclusion ratio. You report only the taxable portion on your tax return.

What Form 1099-R tells you

Your annuity provider is required to send you a Form 1099-R by January 31 each year. This form shows the total amount you received in box 1, and the taxable amount in box 2a. Box 2b shows whether the entire amount is taxable or whether an exclusion ratio was applied.

You use the amount in box 2a when you fill out your tax return. If you received annuity payments from multiple sources, you will receive multiple Forms 1099-R, and you report each one separately. Keep your copy of the Form 1099-R with your tax records — the IRS receives a copy as well, so the amounts must match what you report.

How annuity income affects other parts of your tax return

Annuity income counts toward your total income for the year, which can affect whether you owe taxes and how much. It also counts toward income thresholds that determine whether you can take certain deductions or credits. For example, if your annuity income pushes you over the income limit for the Earned Income Tax Credit or the Saver's Credit, you may lose those benefits.

Annuity income also counts toward the income threshold for Social Security taxation. If you receive both Social Security and annuity payments, the combined income may cause part of your Social Security to become taxable. Additionally, if you are over age 65, annuity income counts toward the income limits for the Additional Standard Deduction.

Reporting annuity income on your tax return

You report annuity income on Form 1040, the main individual income tax return. The taxable amount from your Form 1099-R goes on line 5b (for may have access to retirement distributions) or line 1 (for other income), depending on the source of the annuity and your filing software's instructions.

If you received annuity payments but did not receive a Form 1099-R, contact your annuity provider when ready. You are still required to report the income even if you do not receive the form, but having the form ensures the IRS has the same information you do. If you file without reporting the income and the IRS receives a Form 1099-R in your name, you may receive a notice asking you to explain the discrepancy.

Frequently Asked Questions

Do I have to report annuity income if I did not receive a Form 1099-R?

Yes. You are required to report all annuity income on your tax return regardless of whether you receive a Form 1099-R. However, contact your annuity provider to request the form, because the IRS will receive a copy and will expect your return to match.

What if my annuity payments are less than the taxable amount shown on Form 1099-R?

This can happen if you received a partial distribution or if the form covers a period longer than your actual payment dates. Review the form carefully and contact your annuity provider to clarify. You report only the amount you actually received, not the amount on the form if they differ.

Can I deduct losses on an annuity from my taxes?

If your annuity is worth less than what you paid for it when you surrender it, you may be able to deduct the loss, but only if the annuity was non-may have access to (purchased with after-tax money). Losses on may have access to annuities cannot be deducted. Consult a tax professional about your specific situation.

Does my annuity income count toward Medicare premium surcharges?

Yes. Annuity income is included in your modified adjusted gross income (MAGI), which determines whether you pay higher Medicare Part B and Part D premiums. Higher income can trigger surcharges that increase your monthly premiums.