Deferred Annuity Taxation 2026: Withdrawals, Surrender, 10% Tax

What the Code says, rule by rule

Everything in this table is in the statute or in IRS Publication 575 (2025). The search for “deferred annuity taxation” mostly returns insurer guides; they describe the same rules without the dollar cost by bracket, which is the next section.

Source: 26 U.S.C. 72 (Cornell Legal Information Institute) and IRS Publication 575 (2025), read and saved on October 27, 2026.

Two consequences are easy to miss. The gain-first rule applies to contracts entered after August 13, 1982; Pub. 575 gives a different order for money invested before that date (cost first on the pre-1982 part). And because the order is gain first, a partial withdrawal never lowers the later tax on the same gain: the whole gain is taxed before the first dollar of cost comes out, so the choice is how to spread it across years and brackets.

What $50,000, $100,000 or a surrender costs, by bracket

The example is a $250,000 contract with $150,000 of cost, so $100,000 of gain (our assumption). The first $100,000 withdrawn is all gain, so a $100,000 partial withdrawal and a full surrender with no surrender charge have the same tax. Federal tax below is our arithmetic from the 2026 tables of Rev. Proc. 2025-32 (joint: 12% to $100,800, 22% to $211,400, 24% to $403,550, 32% to $512,450; standard deduction $32,200). “Other taxable income” is the taxable income before the annuity gain; modified adjusted gross income is that plus the standard deduction plus the gain; we assume no other investment income and no other adjustments.

Source: Rev. Proc. 2025-32 section 4 Table 1 and standard deduction; 26 U.S.C. 72(e), 72(q), 1411; our arithmetic. Percent is the share of the withdrawal. State tax, Social Security and Medicare effects are not included.

Source: Rev. Proc. 2025-32 section 4 Table 3 and standard deduction ($16,100); 26 U.S.C. 72(e), 72(q), 1411 ($200,000 threshold); our arithmetic.

What the tables show (our arithmetic):

• Splitting the gain helps where the gain crosses a bracket. A couple with $150,000 of other taxable income pays $23,996 on $100,000 in one year but $22,000 on $50,000 in each of two years if the income is the same both years, a saving of $1,996. A single filer with $150,000 pays $30,370 against $25,224, a saving of $5,146. The saving depends on where the second half would land: $4,080 for a couple at $60,000 of other taxable income, $1,126 at $450,000, and nothing at $300,000, where both halves are taxed at 24% plus the same NIIT.
• The 10% tax is a flat add-on. It is $5,000 on $50,000 and $10,000 on $100,000 at any income, so for a 52-year-old in the 12% bracket it costs nearly as much as the income tax. The exceptions in the table above are the only ways to avoid it before 59 1/2.
• At 60 and at 68 the table is the same; age matters here only for the 59 1/2 line. Other 2026 effects of the extra income, such as the provisional-income test for Social Security and the Medicare IRMAA tiers, are in our guides on Social Security and rental income and IRMAA brackets; we have not added them to the table.
• Ordinary rates, not capital gains rates. Pub. 575 has the taxable amount of a nonperiodic distribution entered on Form 1040 line 5b with other pension and annuity income; on our reading it is taxed at the brackets above, not at the 0%, 15% or 20% rates for long-term gains.

Surrender: why a full surrender can be taxed on less

For a complete surrender, 72(e)(5)(E) and Pub. 575 tax the amount received only above the remaining cost. For a partial withdrawal, 72(e)(3)(A) and Pub. 575 test the contract's gain on the cash value “figured without considering any surrender charge.” In the example with a 5% surrender charge:

Source: 26 U.S.C. 72(e)(3)(A), (e)(5)(E); IRS Pub. 575 (2025); our arithmetic. The sources we read do not say whether a charge withheld from a partial withdrawal reduces the amount treated as received; ask the insurer how it will fill in boxes 1 and 2a of the Form 1099-R before you sign.

Annuitize instead of withdrawing: when the tax arrives

If you convert the contract to payments for life or for 10 years or more, 72(a)(2) and the exclusion ratio in 72(b) replace gain-first. For a nonqualified annuity Pub. 575 requires the General Rule, and Pub. 939 Table V gives 20.0 as the expected-return multiple at age 65. Our SPIA page has the full tables: annuity payout calculator and exclusion ratio.

Take the same $250,000 and $150,000 of cost, and assume a $15,000 annual payment (an assumption, not a quote). Expected return is $15,000 times 20.0, or $300,000, so the exclusion ratio is 50.0% and $7,500 of each year's payment is taxable for 20 years. Taking $15,000 a year by withdrawal instead, with no growth, is taxable at $15,000 a year for six years and $10,000 in year 7, then tax-free until the contract is empty after 16.67 years.

Source: 26 U.S.C. 72(a)(2), 72(b), 72(e); IRS Pub. 939 Table V (age 65: 20.0); our arithmetic. The paths are not the same deal: annuitizing is irrevocable and keeps paying after year 16.67, while the withdrawal path leaves a liquid contract that runs out. The crossover, where annuitized taxable income passes the $100,000 gain, is year 13.33.

The pattern is timing, not a lower total: gain-first puts the whole gain in the first seven years, while the exclusion ratio spreads it. If your bracket is higher now than it will be later, the spread helps; if the reverse, it does not. Annuitizing before 59 1/2 may fall under the immediate-annuity or periodic-payment exceptions in 72(q)(2); check the contract's own terms and the insurer's reporting.

Reading the Form 1099-R

The 2026 instructions for Forms 1099-R and 5498 are the guide the insurer follows. Our page on box 7 codes has the full list; these are the ones a deferred annuity uses.

Source: Instructions for Forms 1099-R and 5498 (2026), Table 1 and Box 4; IRS Pub. 575 (2025).

Box 2a is the taxable amount and box 5 is the cost you may recover tax free this year. The instructions tell the payer to withhold 10% of the taxable part of a nonperiodic distribution that is not an eligible rollover distribution; that is a deposit, not the bill, and the table above shows why it can be well short.

Where deferred-annuity advice goes wrong

• Treating cost as first out. The cost comes out last. A $50,000 withdrawal from the example is $50,000 of income, not $20,000 of gain and $30,000 of cost.
• Ignoring the NIIT because it is “just an annuity.” Statute: net investment income includes annuities. For a couple the 3.8% starts at $250,000 of MAGI; in the example it adds $1,224 at $150,000 of other taxable income and $3,800 at $300,000.
• Confusing a withdrawal with a 1035 exchange. A withdrawal is taxed as above; an exchange is reported with code 6 and is not a withdrawal (see the 1099-R table).
• Pledging the contract. A loan against it or a pledge as collateral is a distribution under 72(e)(4)(A).
• Gifting it to a child. The gain is income to you at the time of the transfer under 72(e)(4)(C).
• Assuming a state guaranty makes the exit free. Guaranty limits protect against insurer failure, not tax; see our table of state guaranty limits. If the contract is a buffered index product, its surrender charge schedule decides what you receive. For what happens at death, see inherited annuity taxes; for the 3.8% tax in general, the NIIT guide.

Before you take money out

• Get three numbers from the insurer in writing: current cash value, investment in the contract, and the surrender charge on the amount you plan to take.
• Find the 59 1/2 date. The 10% tax turns on the date of the distribution, so a withdrawal a week before the birthday costs the full add-on.
• Check which bracket the gain lands in, using last year's return and this year's other income, before choosing between one year and two.
• Ask whether the contract was entered before August 14, 1982, which changes the order.

What a reader can do with this

1. Subtract the investment in the contract from the cash value to get the gain; the first dollars you withdraw are that gain.
2. Find your filing status and the income level nearest yours in the tables, and read the cost of $50,000 and $100,000; then test two years against one.
3. If you are under 59 1/2, add 10% of the taxable part, or check whether one of the 72(q)(2) exceptions fits.
4. Compare the gain-first path with annuitizing in the timing table before you ask the insurer for a quote.

FAQ

Sources, read and saved on October 27, 2026: 26 U.S.C. 72 and 1411 (Cornell Legal Information Institute); IRS Publication 575 (2025); IRS Publication 939 (Rev. 12-2025), Table V; Rev. Proc. 2025-32 (2026 rate tables and standard deductions); Instructions for Forms 1099-R and 5498 (2026). The contract values, incomes, payouts and surrender charge are assumptions, and every tax figure and comparison is our arithmetic from those documents. This is analysis of public documents, not investment, legal or tax advice.