South Carolina Insurance Practice Exam

What happens to interest earned if the annuitant dies before the payout start date?

1. It is tax-exempt

2. It is taxable

3. It is forfeited to the insurer

4. It is covered by a beneficiary

The correct answer is: It is taxable

When an annuitant passes away before the payout start date, any interest that has accrued on the annuity is subject to taxation. This is due to the tax-deferred nature of annuities, where taxes are postponed until funds are withdrawn. In the event of the annuitant's death, the Internal Revenue Service (IRS) requires taxation of the earned interest, as it has not yet been distributed to the beneficiary. The taxation rule ensures that the IRS receives revenue on income earned in the annuity account that was not previously taxed. While beneficiaries may receive the principal amount, the interest earned is viewed separately for tax purposes. It is essential to note that while beneficiaries may receive the contract's value, including any accumulated interest, the IRS will still impose taxes on that interest as income to the beneficiary, disrupting the notion of tax exemption or forfeiture to the insurer. Hence, understanding the implications of interest earned in the context of tax liabilities upon the annuitant's death is crucial for financial planning and compliance.