What happens to tax-deferred growth in a lump sum annuity when it is withdrawn?

When a lump sum annuity's funds are withdrawn, the tax-deferred growth becomes taxable at that point. This means that any earnings accrued in the annuity are subject to taxation when the money is taken out. The advantage of tax-deferred growth is that the annuity allows the funds to grow without taxes while they remain within the account. However, once those funds are withdrawn, the IRS considers that growth to be taxable income in the year it was received.

This principle is foundational in understanding how annuities work in terms of taxation. It clarifies the timing of tax liabilities and helps annuity holders plan for the tax impact when they decide to access their funds.