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

How much basis does a person have in a qualified annuity if the entire amount is withdrawn?

1. The entire amount withdrawn is basis

2. The basis is equal to the amount invested

3. The basis is zero, since it's taxed as income

4. Basis is determined by market conditions at withdrawal

The correct answer is: The basis is zero, since it's taxed as income

In the context of a qualified annuity, the basis refers to the amount of money that a person has contributed to the annuity, which is not subject to taxation upon withdrawal. However, any amounts that have grown or accrued during the duration of the annuity, often through interest, dividends, or investment appreciation, are taxable as ordinary income when withdrawn. When the entire amount from a qualified annuity is withdrawn, the disposition of the basis becomes critical. If someone has contributed after-tax dollars, the basis would only be the amount that was initially invested. However, in a qualified annuity, most contributions are made with pre-tax dollars, meaning that upon withdrawal, the money is considered income. Consequently, the basis for tax purposes is effectively zero since the entire withdrawal is taxed as income. This is because everything withdrawn represents either the original investment (which may have been made pre-tax) or the earnings (which are fully taxable). Thus, the answer indicates that since the entire withdrawal amount from a qualified annuity is taxed as income, there is no basis remaining for tax purposes, validating that the basis is zero in this scenario.