Florida 2-15 Life, Health and Variable Annuity AgentGeneral Knowledge of Life InsuranceMedium
A client purchased a single premium deferred annuity (SPDA) for $100,000. Over five years, the cash value has grown to $125,000. If the client decides to surrender the annuity completely, what amount will be considered taxable income, assuming the client is under age 59½ and no exceptions apply?
- A$125,000
- B$0
- C$25,000
- D$100,000
Show answer & explanationAnswer & explanation
Correct answer: C. $25,000
When a non-qualified annuity is surrendered, withdrawals are taxed on a 'Last-In, First-Out' (LIFO) basis. This means the earnings are considered to be withdrawn first and are fully taxable as ordinary income. The original premium is considered basis and is not taxed until all earnings are withdrawn. In this case, the earnings are $125,000 (cash value) - $100,000 (premium) = $25,000, which is the taxable amount.
Why the other options are wrong
- A. The entire cash value is not taxable; only the earnings portion is taxed first.
- B. This is incorrect; the earnings portion of the annuity is taxable.
- D. The original premium is not taxable upon withdrawal, only the earnings.
Non-Qualified Annuity Taxation (LIFO)
For non-qualified annuities, withdrawals and surrenders are taxed on a Last-In, First-Out (LIFO) basis, meaning earnings are taxed first as ordinary income. If the annuitant is under 59½, a 10% penalty may also apply.
- LIFO applies: earnings taxed before principal
- Earnings are taxed as ordinary income
- Original premium is considered basis (not taxed until earnings are exhausted)
- 10% penalty for withdrawals before age 59½, unless an exception applies
Memory trick: Last In, First Out: Earnings are the first to exit and incur tax.