Annuity Tax Treatment: Non-periodic Distribution (Lump Sum Withdrawal)

Contract issued before August 14, 1982
Distribution Prior to the Annuity Start Date
The nonperiodic payment is treated on a FIFO basis.
As an example, assume that a taxpayer purchased a deferred annuity in 1981 for $300,000, and the cash surrender value is now $500,000. The contract has not reached its start date. A nonperiodic distribution of up to $300,000 would be tax free, as the taxpayer is withdrawing their investment first.
The previous statement is true even if the pre-August 1982 annuity contract was swapped via the 1035 exchange. However, the IRS may require detailed documentation.
Distribution After the Annuity Start Date
The nonperiodic payment is treated on a LIFO basis.

Contract issued after August 14, 1982
It doesn’t matter if the distribution is taken Prior to or after the Annuity Start Date
The nonperiodic payment is treated on a LIFO basis.
In other words, the withdrawals consist of fully-taxable interest first, and second, tax-free principal to the extent that interest payments are fully exhausted.
In the preceding example, the distribution of $300,000 would be fully taxable $200,000 earning first and then $100,000 out second.
This rule applies to the extent that the cash surrender value of the contract exceeds the investment in the contract.

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