Series 7 practice questionhardPackaged Products — Variable Annuities
A 58-year-old client invested $100,000 in a variable annuity that is now worth $75,000. If the client surrenders the contract (no surrender charge applies), what are the tax consequences?
- AThe client receives $75,000 tax-free since there is a loss✓ Correct answer
- BThe client owes ordinary income tax on $75,000
- CThe client may deduct the $25,000 loss as an ordinary loss on their tax return
- DThe client owes capital gains tax on $75,000 plus a 10% penalty
Explanation
Why A — The client receives $75,000 tax-free since there is a loss
The client invested $100,000 and receives only $75,000 on surrender, so there is no taxable gain or taxable earnings. The surrender proceeds are treated as a tax-free recovery of part of the client's investment in the contract; the 10% early-withdrawal penalty applies to taxable earnings, not to a loss recovery.
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