He Bought a $200,000 Annuity With Savings. His Brother Bought the Same One Inside His IRA, but Only One of Them Pays Tax on the Whole Check

Two brothers walk into the same insurance office in the same week. Each writes a $200,000 check and buys the same immediate annuity from the same carrier. Each will receive the same monthly payment for life. The only difference is where the money came from. One brother funded the purchase from a taxable brokerage account he had been building for decades. The other funded it from a traditional IRA. When the checks start arriving, one brother pays tax on every dollar he receives, and the other pays tax on only part of each payment for years.

This difference stems from which account the money came from, and it is one of the least understood decisions in retirement. Most buyers choose at the moment of purchase without really discussing what it means.

This matters more right now than it did a few years ago. Payout rates on new annuity contracts move with long-term interest rates, and the 10-year Treasury yield sits at 4.78% as of early September 2026, near a 52-week high of 4.79%. Set that against the FDIC national average 12-month CD rate of 1.71%, and the appeal of locking in a lifetime income stream is clear.

How After-Tax Savings Change the Math

The brother who paid with taxable savings already paid income tax on that money the year he earned it. The insurance company knows this, and the tax code treats his premium as basis, meaning principal that has already been taxed and should not be taxed again on the way out. When payments begin, the insurer applies an exclusion ratio. A portion of each monthly check is treated as a nontaxable return of his own principal, and the remainder is treated as taxable earnings.

The favorable treatment is not permanent. Once he has recovered his full basis, which happens if he lives long enough to receive enough payments, the exclusion ends. From that point forward, every dollar of every check is fully taxable ordinary income. The tax break has an expiration date tied to his own longevity. The longer he lives, the more his tax picture resembles his brother’s.

Inside the IRA, Every Dollar Is Taxable

The other brother funded the same contract from a traditional IRA. Money inside that account was never taxed on the way in, so there is no basis to recover and nothing to exclude. Every dollar that comes out is ordinary income, whether it arrives as an annuity payment or a plain withdrawal. The exclusion ratio simply does not apply.

Buying an annuity inside a tax-deferred account does not create a tax advantage, because the account already had one. He paid an insurance company purely for a guarantee.

Why Anyone Would Still Buy an Annuity in an IRA

A guaranteed lifetime income stream solves a real problem: outliving your money. It converts an uncertain balance into a check that keeps arriving no matter how long he lives. For someone who worries about overspending a lump sum or who does not want to manage withdrawals in their eighties, that discipline has value. The guarantee itself is the point (if the appeal is the paycheck rhythm rather than the insurance wrapper, we walked through how to build that from ordinary savings, without handing a premium to a carrier, in a free guide here).

Complications Both Brothers Should Have Asked About

Neither brother gets the lower rates that apply to qualified dividends and long-term capital gains. The earnings portion of an annuity payment is ordinary income for both. For the savings brother, that is a genuine cost of choosing an annuity over simply investing the same money in a diversified portfolio.

Both brothers’ payments also raise the income measure that determines how much of their Social Security benefit is taxable, and both can push them into the income-related Medicare surcharge, which is assessed on income from two years earlier. The IRA brother’s exposure is larger because the entire payment counts toward that measure, not just the earnings portion.

What a beneficiary inherits, and how those inherited payments are taxed, differs sharply between a non-qualified annuity and one held inside an IRA. Ask that question before signing the application.

Verdict and the One Question to Ask First

The savings brother made the better decision, at least for the first stretch of retirement, because he bought a guarantee and a partial tax shield on the earnings, while his brother bought only the guarantee. That edge fades as basis is recovered. The single question worth asking before buying an annuity in either pocket is simple: what problem am I paying the insurance company to solve, and is a tax-deferred account the right place to solve it?

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