Annuities✓ Verified · outline & fact-checked · Sep 2026Difficulty 2/5
What happens to annuity payments received after the annuitant has fully recovered the investment in the contract?
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
Once the annuitant has recovered all basis through the exclusion ratio, subsequent annuity payments are fully taxable as ordinary income. The exclusion ratio applies only while basis remains unrecovered; IRC Section 72(b) provides that if the annuitant outlives the expected return period, all later payments are included in gross income. This is why payments continuing beyond the life expectancy become fully taxable.
Why the other options are wrong
- B) Basis recovery is finite; once it is complete, there is no remaining tax-free amount to exclude from later payments.
- C) The ratio is not 'reset'; it has simply accomplished its purpose, and later payments are taxed in full.
- D) The insurer keeps paying under the annuity terms; tax treatment, not payment obligation, changes after basis recovery.
Memory hook
Outlive the expected return and the tax shelter expires — the checks keep coming, fully taxable.