Section 1411 Annuity Payments: MAGI, Form 8960, and Exclusions

The Net Investment Income Tax on annuity payments applies only to non-qualified annuities, and only to the earnings portion of each check. Payments from annuities held inside a qualified retirement plan — a 401(k), traditional or Roth IRA, 403(b), or 457(b) — are excluded from net investment income entirely. If your annuity was bought with after-tax dollars outside a retirement plan, the taxable share of each payment gets stacked into your net investment income and can be hit with an additional 3.8% surtax once your modified adjusted gross income crosses $200,000 single or $250,000 married filing jointly.¹

The 3.8% rate is not applied to your full MAGI overage. It hits the lesser of your net investment income or the amount by which MAGI exceeds your threshold.² So if you are $20,000 over the threshold but only $5,000 of your income is investment income, the tax runs on $5,000. Married-filing-separately filers hit the threshold at $125,000. The numbers are fixed in statute and do not adjust for inflation.¹

Which Annuities Are Subject to NIIT and Which Are Not

The statute treats annuities differently based on the wrapper around them, not the payment schedule inside. Section 1411 lists annuities as a category of investment income, but it carves out distributions from qualified plans by cross-reference.² The excluded plan types are:

401(a) plans, including traditional 401(k)s and profit-sharing plans
403(a) and 403(b) plans for public school and nonprofit employees
408 and 408A plans: traditional IRAs, SEP IRAs, SIMPLE IRAs, and Roth IRAs
457(b) deferred compensation plans for government and tax-exempt employees

If your employer’s plan bought an annuity with plan assets, or you annuitized your IRA balance, those payments stay outside the NIIT calculation regardless of how they arrive. The Form 8960 instructions carry the same list on line 3, telling filers to exclude annuity payments from those plan types.³

Everything else is fair game. A commercial deferred annuity you bought from an insurance company with taxable savings, an immediate annuity funded from a brokerage account, a variable annuity held outside any retirement plan — the taxable earnings in each of these are treated as investment income in the same bucket as interest and dividends.⁴

How Much of Each Payment Counts

Only the earnings portion of a non-qualified annuity payment is net investment income. The premiums you paid in are recovered tax-free through the exclusion ratio under IRC Section 72, which divides your investment in the contract by the total expected return over the contract’s life based on IRS actuarial tables.⁵⁶

Fixed Annuities

The ratio stays constant while you are recovering basis. If you paid $100,000 in premiums against an expected return of $200,000, your exclusion ratio is 50%. On a $1,000 monthly check, $500 is tax-free return of principal and $500 is taxable earnings that flow into your net investment income. Once you have recovered the full $100,000, the ratio drops to zero and every dollar of every subsequent payment becomes fully taxable and fully includible in NII. Living past your actuarial life expectancy can make your NIIT exposure worse in later years.

Variable Annuities

Variable contracts use a fixed dollar exclusion rather than a percentage. Divide your investment in the contract by the number of years payments are expected to last, and that annual amount comes off the top of each year’s payment. If your excludable amount is $8,000 and you receive $12,000 one year, $4,000 is taxable NII. If markets push the next year’s payment to $15,000, still only $8,000 is excluded and $7,000 counts.

Withdrawals Before Annuitization

Pulling money out of a deferred non-qualified annuity before you annuitize triggers the earnings-first rule under Section 72.⁵ Every dollar withdrawn comes out of accumulated gains before you touch your principal. A contract with $40,000 of gains on $100,000 of premiums treats the first $40,000 of withdrawals as entirely taxable, and all of that goes into net investment income. A full surrender pulls the entire gain component into NII in one year, which almost guarantees NIIT exposure for anyone near the thresholds. Withdrawals before age 59½ also carry a separate 10% early withdrawal penalty on top of regular income tax and NIIT.

The MAGI Trap With Qualified Distributions

This is where taxpayers who assume they are safe get caught. Qualified plan distributions are excluded from net investment income, but they are not excluded from MAGI. For NIIT purposes, MAGI is essentially your Form 1040 AGI with a narrow foreign earned income adjustment.⁴ A $100,000 traditional IRA withdrawal generates no NII, but it adds $100,000 to your MAGI, and that can push you over the threshold so that every dollar of your other investment income — including a non-qualified annuity you also own — becomes exposed to the 3.8%.

Qualified Roth IRA distributions avoid this trap. They are excluded from net investment income and, because they are tax-free federally, they do not raise MAGI either. Converting traditional balances to Roth in a lower-income year can hold down future MAGI spikes that would otherwise activate NIIT on other holdings.

Reporting the Income on Form 8960

Non-qualified annuity income subject to NIIT is reported on Form 8960.⁷ Your insurance company sends Form 1099-R each year with the numbers you need. Distribution code “D” in box 7 flags amounts subject to the NIIT. The taxable amount in box 2a goes on line 3 of Form 8960.³

If box 2b is checked, meaning the payer could not determine the taxable amount, you calculate it yourself using the exclusion ratio and the guidance in Publications 939 and 575.³ Keep your premium payment records; those establish your investment in the contract. The same payment also appears on Form 1040 lines 5a (gross) and 5b (taxable).⁸

Part II of Form 8960 lets you subtract certain deductions before the 3.8% rate applies. Investment interest expense, and state and foreign income taxes allocable to investment income, can reduce NII if they were properly deducted on your main return. Investment advisory fees and other miscellaneous itemized deductions cannot be used against NII because they are disallowed for regular tax purposes.³

Ways to Reduce the Bill

The tax is computed year by year, so when you take income matters as much as how much you take.

Annuitize instead of taking lump sums from a non-qualified contract. Annuitization applies the exclusion ratio and spreads the taxable earnings across many years, keeping each year’s NII contribution smaller than an earnings-first withdrawal would.
Do not stack a large traditional IRA withdrawal into the same year you receive substantial non-qualified annuity payments. The IRA money raises MAGI and can push the annuity earnings into the 3.8% zone even though the IRA money itself is not taxed by NIIT.
Fund 401(k) and traditional IRA contributions while you are still working. Every dollar reduces current MAGI and can keep you below the threshold in years you also have annuity income.
Convert to Roth in years when your MAGI sits comfortably below the threshold. Future qualified Roth withdrawals will not inflate MAGI or trigger NIIT on other holdings.

Annuities Held Inside Trusts

One boundary worth knowing: a non-qualified annuity owned by an irrevocable trust runs into the NIIT at a far lower income level than an individual would. The trust threshold sits where the top trust bracket begins, roughly $16,000 for 2026, and the 3.8% applies to undistributed net investment income above that figure.⁹ Distributing the annuity earnings out to beneficiaries shifts the calculation to their personal returns, where the $200,000 or $250,000 threshold is far more forgiving. Grantor trusts do not face the trust-level NIIT because the grantor reports all the income personally. Charitable remainder trusts and qualified retirement plan trusts are exempt.

1
Internal Revenue Service. Net Investment Income Tax
2
Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax
3
Internal Revenue Service. Instructions for Form 8960
4
Internal Revenue Service. Questions and Answers on the Net Investment Income Tax
5
Office of the Law Revision Counsel. 26 USC 72 – Annuities, Certain Proceeds of Endowment and Life Insurance Contracts
6
eCFR. 26 CFR 1.72-4 – Exclusion Ratio
7
Internal Revenue Service. About Form 8960
8
Internal Revenue Service. Publication 575 – Pension and Annuity Income
9
Office of the Law Revision Counsel. 26 USC 1411 – Imposition of TaxQuestions and Answers on the Net Investment Income Tax