How are annuity contributions taxed?

• A. After-tax dollars
• B. Pre-tax dollars
• C. Tax-deductible dollars
• D. Tax-free dollars

Answer: (A)

Contributions to a typical annuity are made with after-tax dollars. You don’t get a tax deduction for these payments, so the money you put in has already been taxed. The upside is that the account grows tax-deferred, meaning you don’t pay taxes on the investment gains while they remain inside the contract. When you take withdrawals, the distributions are taxed on the earnings portion, while the part that represents your original contributions (the cost basis) comes back tax-free. In other words, you’ve already paid taxes on the money you contributed, and future taxes apply mainly to the growth rather than the principal. This differs from scenarios where contributions are made with pre-tax dollars, which would be deductible upfront and taxed when withdrawn. It also isn’t tax-free at withdrawal, unless you’re in a specialized tax-free (Roth) arrangement, which is not the standard annuity.