Annuity service fees generally are assessed annually. Such fees cover administrative expenses, such as the cost of transferring funds, tracking payments and issuing withdrawals. Annuity service fees aren't tax deductible. While there are some tax breaks associated with annuities, you'll eventually have to pay the Internal Revenue Service its share.
Tax Benefits and Liabilities
Money you invest in the annuity grows tax deferred during the accumulation phase. Once you begin taking withdrawals in the distribution phase, you'll pay taxes on the gains. If you choose a lump sum distribution, taxes are assessed on the difference between the amount you contributed to the annuity and the payout amount. The earnings are taxed as ordinary income in the year you take the distribution, so a large lump sum could place you in a higher tax bracket. If you choose to take the payments instead of the lump sum, each payment is divided into principal and earnings. You'll only pay taxes on the earnings portion of each payment.
Since annuities are designed to help you save for retirement, penalties apply if you tap into it too early. If you begin taking withdrawals before age 59 1/2, you may be subject to an additional 10 percent IRS tax penalty. There are some exceptions, however. For example, the penalty isn't assessed if you become totally and permanently disabled. You aren't required to take annuity withdrawals during your lifetime. You can designate a beneficiary to receive the annuity in the event of your death.