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
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
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.