Annuities✓ Verified · outline & fact-checked · Sep 2026Difficulty 2/5
All of the following statements about the federal income tax treatment of unpaid annuity benefits paid to a beneficiary after the annuitant's death are correct EXCEPT:
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Answer & full 3-part explanation (select an option above, or peek)
Why C is correct
Statement C is incorrect, so it is the exception. Unpaid annuity benefits are not excluded from income merely because they are paid on account of the annuitant's death: under IRC Section 72, only the portion representing the owner's investment in the contract is recovered tax-free, and the balance is taxable ordinary income to the beneficiary. The Section 101(a) death-benefit exclusion belongs to life insurance proceeds, not to annuity death benefits - the distinction the exam objectives specifically emphasize.
Why the other options are wrong
- A) This statement is correct: the investment in the contract is a tax-free return of capital, so it is not the exception.
- B) This statement is correct: annuity death benefits are governed by Section 72's cost-recovery rules rather than Section 101, so it is not the exception.
- D) This statement is correct: the gain above basis is ordinary income reported by the recipient, so it is not the exception.
Memory hook
Annuity leftovers to a beneficiary are taxable over basis — life insurance tax magic does not apply here.