When are taxes on earnings in a variable annuity paid?

• A. Taxes are paid on withdrawals only at death.
• B. Taxes are paid on withdrawals or annuitization, with earnings taxed as ordinary income.
• C. Earnings are tax-free forever.
• D. Taxes are paid yearly on the contract value.

Answer: (B)

Tax treatment for variable annuities centers on when you take money out and what portion is earnings. The money inside a variable annuity grows tax-deferred, so you don’t pay taxes on the earnings each year during the accumulation phase. Taxes become due when you withdraw money or convert the contract into a stream of payments (annuitization). At that point, the portion of the withdrawal that comes from earnings is taxed as ordinary income, while the portion that represents your original contributions is returned tax-free. If you withdraw before age 59½, a 10% early withdrawal penalty often applies in addition to ordinary income taxes. This is why the correct understanding is that taxes are paid on withdrawals or annuitization, with earnings taxed as ordinary income.