Tax TreatmentQuestion 229 of 315
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% early-withdrawal penalty
c.Determine whether the contract qualifies as life insurance
d.Allocate premium between the cost basis and the 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)Practice all 315 questions free — no signup required.
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Reviewed by John Zihao Zhang — California-Licensed Life Insurance Agent (CA Dept. of Insurance License #4396095 — verify)