Final answer:
If an annuitant withdraws funds from their annuity prior to age 59 ½, they will face income tax and an additional 10% early withdrawal penalty. Exceptions to the penalty are limited.
Step-by-step explanation:
If an annuitant withdraws funds from their annuity prior to age 59 ½, there are tax consequences. The funds withdrawn will be subject to both income tax and an additional 10% early withdrawal penalty. This is because annuities are typically funded with pre-tax dollars, so any withdrawals are taxed as ordinary income.
For example, let's say an annuitant withdraws $10,000 from their annuity before turning 59 ½ and their marginal tax rate is 25%. In this case, they would owe $2,500 in income tax on the withdrawal. Additionally, they would have to pay an extra $1,000 (10% of $10,000) as an early withdrawal penalty.
It's important for annuitants to carefully consider the tax implications before making early withdrawals from their annuities. In some cases, there may be exceptions to the early withdrawal penalty, such as for certain medical expenses or first-time homebuyers, but these exceptions are limited.