Tax deferral means the growth inside an annuity is not taxed the year it is credited. You only owe tax when you withdraw money, so the full balance keeps compounding in the meantime.
What is tax deferral?
Tax deferral is what lets the interest inside an annuity grow without an annual tax bill attached to it. Rather than owing tax on earnings the year they land in the contract, the way you would with a bank CD, you postpone that tax until you actually withdraw money. Because nothing gets pulled out for taxes along the way, the entire balance, including growth already earned, keeps compounding year after year.
Why tax deferral matters
Say you place $100,000 into a hypothetical 6-year MYGA paying 5%. A bank CD paying that identical 5% rate, held by someone in a 22% federal bracket, loses part of its interest to the IRS every single year, so less money is left over to keep growing. The MYGA owner, by contrast, keeps the full 5% working until the term ends and a withdrawal is actually taken. Because of that gap, people often talk about a fixed annuity's "tax-equivalent yield" as higher than the number printed on the contract. For someone in a 22% bracket, a 5% deferred rate lands close to what a 6.4% taxable account would pay after tax. Have a licensed strategist run the math for your own bracket and term instead of leaning on a generic example like this one.
When taxes come due
What gets taxed, and how much, depends on what funded the annuity. With a non-qualified annuity, purchased with money you already paid tax on, only the growth is taxable when you withdraw; your original deposit comes back out tax-free. With a qualified annuity, typically funded from a pre-tax retirement account, every dollar you withdraw is taxable. Either way, the taxable portion counts as ordinary income rather than the lower capital gains rate, so talk with a tax professional before you take a withdrawal that could push you into a higher bracket.
Tax deferral is also the main reason people move an existing IRA into a fixed annuity in the first place. Our IRA rollover guide walks through how that transfer works and what to check before you sign.
Frequently asked questions
What is tax deferral on an annuity?
It means the interest your annuity earns is not taxed the year it is credited. Tax is postponed until you actually withdraw money, so the full amount keeps growing untouched in the meantime.
How does tax deferral change a MYGA's real return?
Because nothing is skimmed off for taxes each year, a tax-deferred rate does the after-tax work of a noticeably higher taxable rate. In a 24% bracket, a 5.50% tax-deferred rate is roughly equivalent to a taxable account paying around 7.2%.
When do I actually pay tax on an annuity?
With a non-qualified annuity, funded with already-taxed money, only the growth is taxed on withdrawal. With a qualified annuity, funded from a pre-tax account, the entire withdrawal is taxable. Either way, the taxable part is ordinary income, not a capital gain.
Written and reviewed by
James Forren Warren
Licensed Retirement Income Strategist · License #20551202
James Forren Warren is a licensed Retirement Income Strategist with Tax Free Wealth Plan. For the past five years he has helped individuals and families turn their savings into retirement income they can count on. He writes and reviews the annuity research on this site and keeps it plain: what a product does, what it costs you, and who it actually fits.
Educational only, not investment, tax or legal advice. Tax Free Wealth Plan LLC is a licensed insurance agency, not a registered investment adviser or broker-dealer. Annuities are not bank deposits, are not FDIC insured and are not guaranteed by any government agency. Guarantees are backed solely by the claims-paying ability of the issuing insurance company. Features, rates and availability vary by state and change over time; the contract and disclosure documents govern.