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

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What is the overall taxation on the earnings portion of a Non-Qualified Annuity?

Taxed at a lower rate than ordinary income
Only taxed at the state level
Taxed as ordinary income
Fully exempt from taxation

The correct answer is: Taxed as ordinary income

The earnings portion of a Non-Qualified Annuity is taxed as ordinary income when distributions are taken. This means that any gains or interest earned on the investment within the annuity will be subject to federal income tax at the individual's usual income tax rate upon withdrawal. The reason for this treatment is that contributions to a Non-Qualified Annuity are made with after-tax dollars. Consequently, while the original contributions do not incur taxation upon withdrawal, the growth or earnings accumulated within the annuity are treated like regular income when accessed. This principle aligns with tax regulations designed to ensure that a taxpayer pays taxes on earnings, thus preventing individuals from avoiding taxation on investment growth through these annuities.