Box 1 is taxable unless you enter a corrected amount in box 2a. The IRS instructions state "Generally, you must enter the taxable amount in box 2a."
If the annuity was purchased with after-tax funds, then it’s non-qualified. Non-qualified annuities require tax payments on only the earnings.
The amount of taxes on non-qualified annuities is determined by something called the exclusion ratio. The exclusion ratio is used to determine what percentage of annuity income payments is taxable and how much is not. The idea is to determine the amount of a withdrawal or payment from an annuity is from the already-taxed principal and how much is considered taxable earnings.
Exclusion Ratio Example
- Your life expectancy is 10 years at retirement.
- You have an annuity purchased for $40,000 with after-tax money.
- Annual payments of $4,000 – 10 percent of your original investment – is non-taxable.
- You live longer than 10 years.
- The money you receive beyond that 10-year-life expectation will be taxed as income.
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