South Carolina Life and Health Practice Exam 2025 – 400 Free Practice Questions to Pass the Exam

The correct answer is that interest in a non-qualified annuity is typically taxed after the exclusion ratio has been calculated. In a non-qualified annuity, contributions are made with after-tax dollars. As such, when withdrawals are taken, the amount that has already been taxed (the return of principal) is not subject to taxation again.

The exclusion ratio helps to determine what portion of each withdrawal is considered a return of principal versus what portion is taxable interest. Tax is only applied to the interest earnings on the contract, and that tax is triggered only after the exclusion portion (return of principal) has been accounted for. Therefore, once the annuitant begins to withdraw funds, they will calculate the exclusion ratio to determine how much of the withdrawal consists of tax-free return of contributions and how much is taxable interest.

This structure allows for tax efficiency in the disbursement phase of the annuity, as the goal is to minimize or defer taxes until interest earnings are realized through withdrawals.