An annuity is simply a series of payments made at equal intervals. That means that your mortgage, insurance, savings, and pension are all annuities. Mostly what makes something an annuity is the regularity of the payments.
How Annuities Work
Usually, the funds that are paid into the investment are tax-deferred until you start accepting annuity payments. The taxes you pay are only regular income taxes too, which means that you pay taxes on the income just like you would any other income you receive.
The two types of annuities, immediate and deferred, both require you to pay ordinary income tax on your earnings. An immediate annuity is when you give the entire principal to the insurance company.
As mentioned above, you can also buy an annuity with after-tax money – in which case only a portion after your principal is taxable.
Ordinary Income Tax
You only pay taxes on your earnings at the ordinary income tax rate. What’s really exciting about this is that once you retire, your income will go down as you won’t have income from working. You may then be receiving social security retirement, your annuity, and other investment payouts.