Yes, annuity earnings can trigger the 3.8% net investment income tax when your MAGI is over the IRS threshold and the payment isn’t from a qualified plan.
If you’re using an annuity for predictable cash flow, the tax layer can feel sneaky. The net investment income tax (NIIT) is a 3.8% surtax that sits on top of regular federal income tax for higher earners. Some annuity dollars fall into it. Some don’t.
This guide shows what usually counts, what’s often excluded, and a quick way to sanity-check your own numbers before you file. If you’ve been typing “are annuities subject to net investment income tax?” into search, you’re in the right place.
How NIIT Works With Annuity Income
NIIT applies when both conditions are true:
- Your modified adjusted gross income (MAGI) is over the filing-status threshold.
- You have net investment income (NII) for the year.
The IRS lists “non-qualified annuities” as net investment income. The official thresholds and definitions are on the IRS page for the Net Investment Income Tax.
NIIT is 3.8% of the smaller of: (1) your net investment income, or (2) the amount your MAGI exceeds the threshold for your filing status. If your MAGI is under the threshold, NIIT is zero even if you have investment income.
Quick Map Of Annuity Types And NIIT Treatment
| Annuity Payment Source | What Part Is Usually “Income” | NIIT Treatment In Many Cases |
|---|---|---|
| Nonqualified deferred annuity, withdrawals | Earnings portion first (LIFO), then basis | Earnings portion can be NII |
| Nonqualified immediate annuity | Taxable portion under the exclusion ratio | Taxable portion can be NII |
| Qualified plan annuity (401(k), 403(b)) | Plan distribution, taxed as ordinary income | Usually excluded from NII by regulation |
| Traditional IRA annuity payout | IRA distribution (often mostly taxable) | Usually excluded from NII by regulation |
| Roth IRA annuity payout | Often tax-free if qualified distribution | Generally not NII if not gross income |
| Annuity paid as compensation for services | Compensation element | Not “gross income from annuities” for NIIT |
| Foreign retirement plan paying an annuity | Depends on plan and U.S. tax treatment | May be outside “annuity” for section 1411 |
| Annuity in a trust or estate | Taxable earnings in fiduciary income | Can be NII; thresholds differ for estates |
This table is a map, not a filing position. Your contract type, Form 1099-R details, and the source of the payment drive the result.
Are Annuities Subject To Net Investment Income Tax?
Sometimes. The answer turns on two labels that sound alike but behave differently:
- Qualified annuities sit inside a retirement plan or IRA.
- Nonqualified annuities are bought with after-tax dollars outside a plan.
Net investment income includes many taxable annuity earnings from nonqualified contracts. At the same time, NIIT rules exclude distributions from qualified plans and similar arrangements, so many IRA and 401(k) annuity payouts stay outside NIIT even when they’re taxable as ordinary income.
What Counts As Net Investment Income From Annuities
NIIT follows income, not cash flow. With annuities, “income” is generally the taxable portion of the distribution.
- Deferred nonqualified annuity withdrawals often come out earnings-first under the last-in, first-out ordering rule. Early withdrawals can be mostly taxable.
- Immediate annuities bought with after-tax dollars usually use an exclusion ratio. Part of each payment is a return of purchase cost. The rest is taxable earnings.
If that taxable slice is net investment income and your MAGI is above the threshold, NIIT can apply to that slice.
What Often Stays Out Of NIIT
Two common reasons keep annuity dollars out of NIIT:
- Qualified plan and IRA distributions. Regulations generally exclude distributions from qualified plans and arrangements from net investment income for section 1411.
- Non-income amounts. Return of basis is not gross income, so it can’t become net investment income.
When you’re sorting 1099-R forms, the IRS filing instructions help you spot what the IRS expects to be in the NIIT bucket. The Instructions for Form 8960 explain that annuity amounts subject to NIIT should be identified with code “D” in box 7, while many retirement-plan annuity payments are exempt even if they appear on Form 1099-R.
Step-By-Step Check Using Your Tax Documents
You can do a solid first pass with three items: your Form 1040 totals, any Form 1099-R for annuities, and a draft of Form 8960.
Step 1: Check Your MAGI Against The Threshold
Start with adjusted gross income and apply the NIIT definition of MAGI. For many filers with no foreign earned income exclusion, MAGI for NIIT matches AGI. If you’re under the threshold, you’re done: NIIT is zero.
Step 2: Find The Taxable Part Of Each Annuity Payment
On Form 1099-R, the taxable amount is usually in box 2a. If box 2a is blank or “not determined,” your basis records control the split between basis and earnings.
Step 3: Identify Whether The Payment Is Qualified Or Nonqualified
IRA and employer-plan distributions may be excluded from NII even when taxable. Nonqualified annuity earnings are often NII. If a form mixes sources, use the distribution code, payer notes, and your statements to split them.
Step 4: Apply The “Lesser Of” Cap
NIIT only applies up to the amount your MAGI is over the threshold. If you cross the line by $5,000, your NIIT base is capped at $5,000 even if your net investment income is larger.
Common Scenarios That Flip The Result
Large Nonqualified Withdrawal In One Tax Year
A big withdrawal from a deferred nonqualified annuity can stack taxable earnings into one year. That can push MAGI over the NIIT threshold and add net investment income in the same move.
Immediate Annuity Payments In A Taxable Account
With an immediate annuity purchased with after-tax money, only part of each payment is taxable. NIIT, when it applies, follows the taxable part, not the full check.
Qualified Plan Annuity Payouts With Other Investment Income
A qualified plan annuity payout can raise MAGI and activate NIIT on other investment income you already have that year, even if the annuity payout itself is excluded from net investment income.
Sale Of A Business Or Property In The Same Year
People often blame the annuity, then learn the trigger was a separate gain. NIIT is computed on total net investment income for the year, not on one product.
Where NIIT Shows Up On Your Return
NIIT is figured on Form 8960, then carried to your Form 1040 as an extra tax. If you use tax software, it may feel hidden, but the logic is still the same: identify net investment income, apply connected deductions, then apply the MAGI threshold cap.
For annuities, Form 1099-R is the usual starting point. Box 1 shows the gross distribution. Box 2a shows the taxable amount when the payer can compute it. Box 7 may include code “D” to flag amounts the payer treats as subject to NIIT, but that code is not a legal guarantee. If you know a distribution came from an IRA or employer plan, it may still be excluded from net investment income even if the taxable amount is large.
Form 8960 also lets you subtract certain expenses that are properly connected to investment income. Think investment interest expense, state income tax tied to investment income, and other items the form instructions allow. That step matters when your annuity earnings are only one piece of a larger investment picture.
Worksheet: Quick NIIT Triage For Annuity Owners
| Check Item | What To Look At | What It Signals |
|---|---|---|
| Filing status threshold | Single $200k, MFJ $250k, MFS $125k | Below threshold means no NIIT |
| MAGI level | AGI plus NIIT MAGI adjustments | Over threshold activates NIIT test |
| Contract location | Inside IRA/401(k) or outside | Qualified plan payouts often excluded |
| Taxable amount | 1099-R box 2a and your basis records | Only taxable slice can be NII |
| Distribution code | 1099-R box 7, code “D” for NIIT | Clue that payer views it as NII |
| Other investment income | Capital gains, rents, royalties, interest | These can drive NIIT even if annuity is exempt |
| “Lesser of” limit | NII vs MAGI-over-threshold amount | Caps NIIT when you barely cross threshold |
| Deductions tied to NII | Expenses allowed on Form 8960 | Can shrink NIIT base |
Small Example With Real Numbers
Say you file as single. Your MAGI for NIIT is $210,000. You have $30,000 of net investment income total, including $8,000 of taxable earnings from a nonqualified annuity withdrawal.
Your MAGI is $10,000 over the $200,000 threshold. NIIT is 3.8% of the smaller of $30,000 (your NII) or $10,000 (the overage). The smaller number is $10,000, so NIIT is $380.
Mistakes That Create Unneeded NIIT
Treating The Full Payment As Taxable Income
With many annuities, only part of the payment is taxable. NIIT can only apply to the taxable part that is investment income.
Mixing Up Qualified And Nonqualified Sources
A payout from an IRA annuity and a payout from a nonqualified annuity can both show up on 1099-R forms. The NIIT result can still differ.
Missing The Threshold Cap
If you’re barely over the MAGI threshold, the “lesser of” cap can keep NIIT small even with solid investment income.
Records That Make Filing Cleaner
- Contract pages showing premiums, riders, and payout choices.
- Annual statements tracking basis and withdrawals.
- All 1099-R forms and any payer explanations.
- Your Form 8960 draft showing how you classified each annuity payment.
If you took a 1035 exchange, save the transfer paperwork too, since it explains why a new contract started without a taxable event today.
If you’re asking “are annuities subject to net investment income tax?” because you’re close to the thresholds, run the NIIT math before you schedule a large withdrawal. A timing tweak can change whether the 3.8% surtax shows up.