If you're wondering how an annuity is taxed, then here are the basics. Look no further because you will overthink it. In a nutshell, a distribution from a qualified annuity will be taxed at your current income tax rates. If you are 59 1/2 years of age then the early withdrawal penalty does not apply. Otherwise, you will pay a 10% early distribution penalty. You will pay tax only on earnings from a nonqualified annuity. Let me explain.