Question of the Week

An individual made a lump-sum deposit into a variable annuity of $25,000 15 years ago when she was 40. Now the current total value of the annuity has grown to a total of $40,000. She calls her registered representative and asks him to have the annuity company cash in $20,000 and send her a check as soon as possible. The registered representative should inform the client that:

a) The withdrawal will be partially taxed, on the amount of tax-deferred growth, using the IRS table called the Treasury Life Expectancy Multiple.
b) She will be subject to immediate taxation, at the long-term gains rate, on the entire $40,000.
c) She will be subject to taxes, at the ordinary income rate on $15,000, plus a 10% penalty.
d) The $20,000 will be taxed to her at the long-term gains rate.


The correct answer is c).

Early withdrawal from a non-qualified annuity--prior to age 59½, except for death or disability, is penalized at 10% plus ordinary taxes on the growth. This individual is making what is known as a “random withdrawal” to which LIFO (last-in, first-out) taxes apply. The annuity holder never pays taxes on the cost basis again.