525 / Are dividends payable on an annuity contract taxable income?
Taxation of dividends under an annuity contract depends on when the contract was purchased. If the contract was purchased after August 13, 1982, dividends received before the annuity starting date are taxable to the extent the cash value of the contract (determined without regard to any surrender charge) immediately before the dividend is received exceeds the investment in the contract at the same time. If there is no excess of cash value over the investment in the contract (i.e., no gain), further dividends are treated as a tax-free recovery of investment. If the annuity contract was purchased before August 14, 1982, and no additional investment was made in the contract after August 13, 1982, the dividends will be taxed in the same manner as dividends received under life insurance contracts (generally tax-free until basis has been recovered; see Q 22).1
Dividends retained by the insurer as a premium, or other consideration for the contract, are not included in income.2 Dividends paid but left with the insurer to accumulate at interest would not be considered retained as premium or consideration.
If any investment has been made after August13, 1982 in an annuity contract entered into before August14, 1982, dividends allocable to that investment are includable as dividends on a contract entered into after August13, 1982.3 Dividends received under an annuity contract with income allocable to earnings on pre-August14, 1982, and post-August13, 1982, investments are allocable first to investments made prior to August14, 1982, then to income accumulated with respect to such pre-August14, 1982 investments, then to income accumulated with respect to investments made after August13, 1982, and finally to investments made after August13, 1982.4