Tax TreatmentQuestion 229 of 716
When a non-qualified annuity contract is annuitized, the exclusion ratio is used to:
a.Split each periodic payment between a tax-free return of basis and a taxable interest portion
b.Compute the 10% federal tax penalty that applies to withdrawals taken before age 59 1/2
c.Determine whether the annuity contract qualifies as life insurance under the federal tax definition
d.Allocate each premium between the contract's cost basis and its death benefit
Explanation
Under IRC §72(b), the exclusion ratio divides each annuity payment into a non-taxable return of the owner's investment in the contract and a taxable interest component. Once the owner has recovered the full investment, subsequent payments become entirely taxable.
Law Reference: IRC §72(b)This topic, taught in full in the California Life & Health Insurance Producer Exam guide. California Life & Health Insurance Producer Exam — Complete Study Guide (2026) — PDF + EPUB, $19.99 · 14-day refund →
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Reviewed by John Zihao Zhang — California-Licensed Life Insurance Agent (CA Dept. of Insurance License #4396095 — verify)