Annuities✓ Verified · outline & fact-checked · Sep 2026Difficulty 3/5
An annuity owner dies, and the contract's death benefit of $95,000 is paid to the beneficiary. The deceased owner's investment in the contract was $80,000. For federal income tax purposes, how much of the $95,000 must the beneficiary include in gross income?
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Answer & full 3-part explanation (select an option above, or peek)
Why C is correct
Under IRC Section 72, when an annuity death benefit is paid, the beneficiary recovers the deceased owner's investment in the contract ($80,000) income-tax-free and includes only the excess ($15,000) in gross income as ordinary income. This differs sharply from life insurance death benefits under IRC Section 101(a), which are entirely excludable. The lump-sum form of payment does not change the result: the taxable element is the gain over the owner's basis whenever and however it is paid.
Why the other options are wrong
- A) The life insurance exclusion of Section 101(a) does not extend to annuities; only the owner's investment in the contract escapes tax, and the gain portion is taxable.
- B) The full amount is not taxable; the $80,000 investment in the contract is a tax-free return of basis to the beneficiary.
- D) Annuity gain is never taxed as capital gain; the $15,000 excess over basis is ordinary income regardless of the payment form.
Memory hook
Annuity death benefit = taxable over basis. Life insurance tax magic does not follow the money here.