Annuities✓ Verified · outline & fact-checked · Sep 2026Difficulty 2/5
An annuity owner dies during the accumulation phase and the beneficiary receives the contract's accumulation value as a lump sum. The portion of the payment representing growth over the cost basis is:
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
When an annuity owner or annuitant dies and the beneficiary receives the annuity's value, the amount exceeding the cost basis, which is the deferred gain, is taxable as ordinary income to the beneficiary. Annuities do not receive the income-tax-free death benefit treatment available for life insurance proceeds. If the beneficiary instead elects to receive the value under a settlement option, the exclusion ratio applies to each payment, taxing only the income portion.
Why the other options are wrong
- B) The income-tax-free death benefit exclusion applies to life insurance proceeds, not to annuity accumulation values.
- C) Annuity gains are taxed as ordinary income; capital gain treatment does not apply to annuity distributions.
- D) A lump-sum distribution does not defer tax; the gain is recognized in the year the beneficiary receives it.
Memory hook
Annuity gains are ordinary income at death, with no life-insurance-style tax-free death benefit. Growth gets taxed.