Earnings inside an annuity grow tax-deferred — you pay ordinary income tax on gains when you withdraw them, not capital gains rates, which is an important distinction for high earners. For nonqualified annuities (purchased outside a retirement account), withdrawals are taxed on a “gains first” basis until all earnings have been distributed. Distributions before age 59½ may trigger an additional 10% federal tax penalty on the taxable portion. Qualified annuities held inside IRAs or 401(k)s follow standard retirement account tax rules, including required minimum distributions starting at age 73.