Series 65: Accumulation Phase For A Nonqualified Annuity

Accumulation Phase for a Nonqualified Annuity

The IRS designates annuities as either qualified or nonqualified. Most annuities are nonqualified, and for the exam, you should assume that the annuity is nonqualified unless otherwise specified.

Contributions into a nonqualified annuity are made with after-tax dollars. So any contributions are not taxed at withdrawal. Any income earned in the annuity is put back into the subaccount and is not taxed until it is withdrawn. This allows earnings to grow tax-deferred.

When an investor makes a random withdrawal during the accumulation or the annuitization period, the withdrawal is taxed using the last in, first out (LIFO) method. With this method, earnings in the account will be assumed to be withdrawn first and are taxable at the annuitant’s ordinary rate. When all earnings have been withdrawn, the remainder, the contribution, can be withdrawn tax-free.

If a random withdrawal is made before an annuitant reaches age 59 1/2 she will need to pay a 10% tax penalty on the withdrawal. The 10% penalty can be waived if the person can’t work due to a death or disability. If the person removes the money in a series of substantially equal payments, IRS Rule 72(t) allows her to remove the money penalty free. This option is known as the substantial