Perhaps the second most attractive annuity feature is the ability to defer taxes during the accumulation period. As long as the earnings generated remain in the annuity account, no federal or state income taxes are due. Once the money is annuitized—given over to the insurance company in exchange for a stream of payments over a predetermined period of time—a portion of each payment is taxed according to an IRS formula, while another portion is considered a return of premium, assuming premiums were paid with taxable dollars.

If the annuity is designated as an individual retirement account (IRA), moneys invested into it may be tax deductible. This means that contributions into the annuity are not taxed in the year contributed. As such, they too can grow tax-deferred until annuitized. At that time, each payment, but not the account value, will be fully taxable. This tax deferral is a considerable advantage, since it allows the annuitant to put off his or her tax bill for many years.