When are taxes on interest, dividends, and capital gains in an annuity paid?

• A. Annually
• B. Upon death
• C. When distributions are made
• D. Never

Answer: (C)

Tax timing for annuities centers on tax deferral until funds are taken out. The growth inside an annuity—interest, dividends, and capital gains—is not taxed as it accrues. Taxes are triggered when you receive distributions from the contract. Each payment typically includes a return of your original principal (not taxed) and a portion representing the earnings (taxed as ordinary income). This is why the timing hinges on distributions.

If you were taxed annually on earnings, the product wouldn’t offer tax deferral. The “never” option isn’t correct because the earnings are eventually taxed when money leaves the contract. The “upon death” option doesn’t generally determine the tax timing for the gains inside the annuity, since taxation is tied to the act of distributing funds, not the occurrence of death.