When you buy an immediate annuity or "annuitize" a deferred annuity, a portion of each payment is considered earnings and a portion is tax-free return of your principal. You are only subject to taxes on the portion of each payment that represents earnings. As these earnings are distributed from the plan they are taxed as ordinary income, not as capital gains, in the year they are received. Once enough payments have been made that you recover all of your tax-free principal, each additional payment will be fully taxable.

Annuitization is an irrevocable decision and there are other, more flexible ways you can access the accumulated value in your annuity.

Instead of annuitizing you might want to take withdrawals. In that case, distributions represent taxable earnings first. After all earnings are distributed, tax-free return of principal remains.

If your annuity is inside an IRA, 401(k) or other qualified retirement plan, 100% of each payment will be subject to taxes (unless a distribution represents after-tax contributions into the plan) you should consult your tax advisor regarding your particular situation.