How are annuities protected
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Tax benefits are well established for annuities. The money inside an annuity contract is allowed to grow tax deferred with withdrawals being taxed at ordinary income tax rates. Also, as long as the annuity is not purchased inside a traditional IRA, there are no laws forcing you to take distributions from your annuity at any age. Also, tax benefits are only extended to annuities if the contract owner is a natural person or a grantor trust.
Creditor protection in an annuity often means that a creditor cannot make a claim against the proceeds of the annuity contract or the cash value during the accumulation phase of the annuity. For states that offer protection against creditors, you may need to annuitize the annuity contract to keep creditors from being able to file a claim against your annuity.
There are limitations on the protections offered by states and the federal government. For creditor claims, only nine states (as of 2010) offer full protection. However,
the contract owner must not receive any of the benefits of the annuity contract. For federal income tax and state income tax purposes, the cash values inside the annuity are tax deferred, but not tax free. When you receive a benefit, you will be taxed at the ordinary income tax rate. There may or may or may not be an exclusion ratio that will lower your tax rate depending on how you receive your annuity benefits.
A common misconception is that annuities have the same protections as life insurance when it comes to both creditors and taxes. This is simply not true. As of 2010, only 23 states offer some kind of protection from creditors for annuities, with nine states offering strong protection as long as the benefits are not payable to the contract owner.
The various protections offered to annuities in many states makes an annuity contract a valuable asset. While not all states offer strong protections from creditors, all annuity contracts receive the favorable tax treatment from the IRS.Source: ehow.com