Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

For variable annuities, what is the tax implication of the death benefit paid to a beneficiary?

1. The entire amount is taxable to the beneficiary

2. Any amount above the contract's basis is taxable to the beneficiary

3. The beneficiary pays tax only on growth

4. Tax-free payments to beneficiaries

The correct answer is: Any amount above the contract's basis is taxable to the beneficiary

When it comes to variable annuities, the tax treatment of the death benefit paid to a beneficiary is determined by the relationship between the contract's basis and the total amount distributed. The correct answer reflects that any amount above the contract's basis, which is essentially the total premiums paid into the annuity before any gains, is considered taxable income to the beneficiary. In this context, the beneficiary receives the death benefit, which may consist of both the premiums paid (the basis) and any investment gains accrued over the life of the contract. The IRS treats this growth as taxable income. Therefore, the tax implications are such that the basis amount is returned to the beneficiary tax-free, while any portion of the death benefit exceeding this basis is reported as taxable income on the beneficiary's tax return. This perspective highlights why the answer correctly identifies the mechanism through which taxes apply to the death benefit, aligning with tax regulations surrounding variable annuities. Understanding this nuance is essential for beneficiaries managing the financial impact of receiving such benefits.