How Should Annuities Be Taxed? 
Non-qualified tax deferred annuities that generate gain in the policy are subject to ordinary income tax at the effective tax bracket rate of the annuity owner . With the exception of lifetime annuitization of deferred annuities and life only immediate annuities , gain is distributed first , then basis . Lifetime annuitization pays the annuity basis as part of the payout until the basis has been distributed ; then the entire payment is policy gain and subject to ordinary income tax . The basis is amortized to the life expectancy of the annuitant . This is called the exclusion ratio , because basis is excluded from taxes . 