Life & Health Insurance Exam (National Portion)Taxes, Retirement, and Other Insurance ConceptsEasy
A 40-year-old client is considering purchasing a non-qualified annuity. They are concerned about the tax implications of withdrawals before retirement. Which of the following statements accurately describes the taxation of withdrawals from a non-qualified annuity before age 59½?
- AOnly the portion of the withdrawal that exceeds the original principal is 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 original principal amount has been recovered.
- DWithdrawals are taxed on a 'first-in, first-out' (FIFO) basis, meaning principal is taxed first.
Show answer & explanationAnswer & explanation
Correct answer: B. Withdrawals are taxed on a 'last-in, first-out' (LIFO) basis, meaning earnings are taxed first.
Non-qualified annuity withdrawals before age 59½ are subject to the 'last-in, first-out' (LIFO) rule. This means that earnings are considered to be withdrawn first and are therefore taxable, often with an additional 10% penalty.
Why the other options are wrong
- A. This is incorrect; the LIFO rule dictates that earnings are taxed first, not just amounts exceeding principal.
- C. This is incorrect; earnings are generally taxed before principal in non-qualified annuities for early withdrawals.
- D. This describes FIFO, which applies to some other investments but not typically early non-qualified annuity withdrawals.
Non-Qualified Annuity Early Withdrawal Taxation
Withdrawals from a non-qualified annuity before age 59½ are taxed on a 'last-in, first-out' (LIFO) basis, meaning earnings are taxed first, often incurring a 10% penalty.
- LIFO rule applies to early withdrawals.
- Earnings are taxed before principal.
- Additional 10% penalty usually applies before age 59½.
- Principal contributions are generally tax-free upon withdrawal.
Memory trick: Annuity withdrawals have a 'LIFO' line for taxes, especially if you're not old enough to 'FIFO' out.