Florida 2-15 Life, Health and Variable Annuity AgentGeneral Knowledge of Life InsuranceMedium
A client purchased a non-qualified deferred annuity with a single premium of $150,000. Over ten years, the annuity accumulated $50,000 in interest. The client then withdraws $70,000. How much of this withdrawal is subject to ordinary income tax?
- A$70,000
- B$20,000
- C$50,000
- D$0
Show answer & explanationAnswer & explanation
Correct answer: C. $50,000
Non-qualified annuities use LIFO (Last-In, First-Out) for withdrawals. This means gains (interest) are withdrawn first and are fully taxable as ordinary income until all gains are exhausted. The client had $50,000 in gains, so the first $50,000 of the withdrawal is taxable.
Why the other options are wrong
- A. This would be true if the entire withdrawal was gain, but $20,000 of the withdrawal consists of the original premium (cost basis), which is not taxed.
- B. This incorrectly assumes the cost basis is partially taxed or that only a portion of the gain is taxed.
- D. This would be true if the withdrawal was less than or equal to the cost basis, but here the withdrawal exceeds the cost basis.
Non-Qualified Annuity Withdrawal Taxation (LIFO)
Withdrawals from non-qualified annuities are taxed on a Last-In, First-Out (LIFO) basis, meaning earnings are withdrawn first and are fully taxable as ordinary income.
- LIFO rule applies
- Earnings are withdrawn before principal
- Earnings are taxed as ordinary income
- Principal (cost basis) is not taxed
Memory trick: Annuity withdrawals: gains first, then principal.