Life · Chapter 9 · Annuity Taxation
Withdrawals: LIFO Taxation & the 10% Penalty
Definition
Early withdrawals, loans, and surrenders from a deferred annuity are taxed LIFO — earnings come out FIRST and are taxed as ordinary income (contracts issued before Aug 14, 1982 use FIFO). Withdrawals before age 59½ add a 10% penalty tax on the taxable amount. For a non-qualified annuity the penalty statute is 26 U.S.C. §72(q); exceptions include reaching 59½, death of the holder, disability, a series of substantially equal periodic payments, an immediate annuity, and amounts allocable to investment made before Aug 14, 1982. A distribution from a qualified plan, 403(b), or IRA is not an exception — it simply moves to §72(t), which imposes its own 10% penalty.
Exam tip
LIFO on annuities mirrors MEC taxation on life policies — earnings first, plus 10% under 59½. Surrender charge (insurer) and 10% penalty (IRS) are SEPARATE hits that can both apply. ⚠️ Classic course error: §72(t) is the QUALIFIED-plan penalty; §72(q) is the NON-qualified annuity penalty. Rolling money out of a pension plan does not escape the 10% — it just changes which subsection charges you.
Easy to confuse with
These are what this term gets tested against — if you can't tell them apart cold, drill the contrast.
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