No matter what type of annuity you purchase, it is subject to a 10 percent IRS penalty for withdrawals of growth of income made prior to age 59 ½. No penalty is imposed on one's principal, i.e. the money put in by the owner is the owner’s money.

It makes no difference how old the annuitant (or owner) of the contract is, if they die then there is no penalty. Also, the Section 72 of the IRS Code states that the penalty is waived if the annuitant (or owner) is disabled. Generally, it must be the death or disability of the annuitant, not the contract owner or beneficiary, except where the contract is owner-driven, in which case all IRS penalties will be waived upon death or disability of the owner.

If the contract is annuitized, it will avoid penalty, but such annuitization must be elected by the contract owner within one year after investing in the annuity. The age of the owner does not have to be 59 ½, indeed it is irrelevant.

The final way in which the 10 percent IRS penalty can be avoided is the contract owner being age 59 1/2 or older.

Because of these penalties, annuities are usually recommended for younger people unless it is part of a retirement plan such as an IRA or pension plan or profit-sharing plan. Of course, there is always the exception of the person who has sufficient funds so that they would not have to touch the funds in case of an emergency. Annuities are ideal candidates for the investor who is near or past age 591/2.

Unless the contract is “owner-driven”, the owner can be any age, from newborn to centenarian. But even with the penalty, it could still make good sense for a young person(s) but would depend upon how soon the money is withdrawn and the assumed rate of growth.

Inside an annuity, the contract-holder’s money will grow and compound tax-deferred, not tax-free. To say it another way, any and all income tax liability can be postponed indefinitely. The death of one spouse will not trigger income taxes provided that the beneficiary was the surviving spouse. What happens when the surviving spouse remarries? The survivor can name themselves as the beneficiary and can name a new partner as the annuitant. When the last spouse dies, the beneficiary(s) can postpone taxes for up to an additional five years.

Income taxes are always due in the year in which income or growth of the fund is received. The return of principal is never taxed, regardless of who receives the money. The amount of taxes on the growth will be based on the tax bracket of the person receiving the funds. Unfortunately the taxable portion is always considered as ordinary income, and does not qualify for capital gains treatment.

As is obvious, taxes will have to be paid at some time or other. This may be considered as a “negative” but perhaps it is not all bad. For instance, the owner of the annuity decides when withdrawals are to be made. Therefore, one would attempt to take out the money when they are at the lowest income tax bracket, i.e. their income is the lowest. Frequently this is when the person retires.