Florida 2-15 Life, Health and Variable Annuity AgentFlorida Laws and Regulations Specific to Life Insurance and AnnuitiesHard
An agent is discussing the tax implications of annuities with a Florida client. The client asks about the taxation of withdrawals from a non-qualified deferred annuity during the accumulation phase. Which statement accurately describes how these withdrawals are taxed?
- AOnly withdrawals made after age 59½ are subject to taxation.
- BWithdrawals are taxed on a 'last-in, first-out' (LIFO) basis, meaning earnings are taxed first.
- CAll withdrawals are tax-free until the full principal amount has been recovered.
- DWithdrawals are taxed on a 'first-in, first-out' (FIFO) basis, meaning principal is recovered tax-free first.
Show answer & explanationAnswer & explanation
Correct answer: B. Withdrawals are taxed on a 'last-in, first-out' (LIFO) basis, meaning earnings are taxed first.
For non-qualified deferred annuities, withdrawals made during the accumulation phase are taxed on a LIFO basis. This means that earnings (which are taxable) are considered to be withdrawn first, before the tax-free return of principal. Additionally, a 10% penalty may apply to withdrawals before age 59½.
Why the other options are wrong
- A. While a 10% penalty may apply to withdrawals before 59½, the taxation of earnings (LIFO) applies regardless of age, provided earnings are withdrawn.
- C. This describes the taxation of principal, but earnings are taxed first under LIFO.
- D. FIFO applies to qualified plans and life insurance cash value withdrawals, not non-qualified annuity withdrawals during accumulation.
Annuity Withdrawal Taxation (LIFO)
For non-qualified deferred annuities, withdrawals during the accumulation phase are taxed on a 'last-in, first-out' (LIFO) basis, meaning earnings are taxed before principal is recovered.
- Applies to non-qualified annuities
- Earnings taxed first
- Principal is tax-free when withdrawn (after earnings)
Memory trick: LIFO: Last In, First Out means Earnings are Taxed First Out!