How Are Annuity Gains Taxed? 
If you purchase a deferred annuity with pre-tax money , the entire balance , including the gains will be taxable . As long as the money stays inside the annuity , the taxation is deferred . A deferred annuity has an accumulation phase and a distribution phase . During accumulation , the annuity grows untaxed . When the annuity is paid out during the distribution phase , the payouts are taxed at ordinary income tax rates for you during that year . If you buy a deferred annuity with after tax dollars then a portion of the payouts will be a tax free return of your principal . It is considered `` last in , first out '' meaning that withdrawals are taxed until the interest and earnings portion is depleted . After that , your principal can be withdrawn without taxes . 