Charlie, Virginia

Dear Charlie,

Payments from annuities are taxed at your normal income tax rate, but you may not have to pay taxes on all of that income. Your taxable annuity income will depend on how much you paid in premiums.

If you have already paid income taxes on the money you used to buy the annuity, you will only have to pay income taxes on the money that was earned in the annuity. For example, says Jeff Thompson, a tax manager with Jackson National Life Insurance Co., if you paid $80,000 for an annuity worth $100,000, you would have to pay income taxes on the $20,000 gain. So if you took payment from the annuity over 10 years, you would receive $8,000 per year tax free, but you would need to pay income taxes on the additional $2,000.

The formula used to calculate your taxable annuity income can be very complicated, especially with variable annuities, but in general you must pay income taxes on any money you receive from the account above what you paid in after-tax dollars, says Thompson.

If your annuity was paid with pre-tax dollars and is within an account such as a 401(k) or 403(b) retirement plan, you will have to pay income taxes on the full amount of your annuitization payments, says Thompson.

Be sure to have your agent explain in detail how payments from any annuity product will be taxed before you buy it. Also, remember that there could be tax consequences if you surrender or exchange your annuity, so it is doubly important to make sure you buy the product that is right for you. For more information, use the Insure.com Life Insurance & Annuity Tax Tool.

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Disclaimer: We are journalists, not financial planners or insurance brokers. Nothing we say should be interpreted as a recommendation to buy or sell any insurance product, or to provide other financial or legal advice.