Advanced Underwriting Consultants

Question of the Day – August 3

Ask the Experts!

Here’s the question of the day.

Question: How are distributions from an annuity with a special extended income account taxed?

Answer: Withdrawals from a nonqualified deferred annuity (NQDA) are taxed on a gain-first basis.  Gain is measured by subtracting the owner’s basis in the contract from the policy’s gross cash value.  A taxable distribution may be subject to the 10% penalty tax if the owner of the contract is younger than age 59 ½.

Once all the gain is distributed, the distribution is a tax-free return of the policy owner’s basis.

Some new NQDA designs have an enhanced withdrawal account.  That feature allows the policy owner to draw additional income from the annuity, even if the policy’s cash value is zero.  So what happens, tax-wise, after all the gain and all the basis has been recovered, and there is still value left in the policy?

The short answer is that we do not know for sure.  The IRS has not given us reliable guidance with regard to the new contract designs.  The likeliest result, in our opinion, is that distributions taken after both gain and basis have been fully drained from the NQDA is that distributions will be fully taxable once again.

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