Annuities✓ Verified · outline & fact-checked · Sep 2026Difficulty 2/5
When the owner of a non-MEC nonqualified deferred annuity takes a partial withdrawal, the amount taxable as ordinary income is determined under which rule?
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
Under IRC Section 72(e), distributions from an annuity that are not part of a scheduled income stream are taxed on a last-in-first-out basis: earnings are considered withdrawn first and are taxable as ordinary income, with basis recovered last. If the contract is a MEC, the same LIFO rule applies, and a 10 percent penalty may also apply to the taxable portion before age 59 and a half.
Why the other options are wrong
- B) Tax-free-until-basis-recovered (FIFO) describes the treatment of some other products, but annuity withdrawals are LIFO: gain first.
- C) Ordinary income tax applies to the taxable gain at any age; the age 59-and-a-half threshold governs the 10 percent penalty, not the basic income tax.
- D) Annuity withdrawals are not loans; policy loans exist in life insurance, and annuity withdrawals are distributions subject to income tax.
Memory hook
Annuity withdrawals: LIFO — the IRS grabs the gain first, your basis waits its turn.