548 / What are the income tax results when an annuitant makes a partial lump sum withdrawal and takes the same payments for a different term?

If an annuity contract was purchased before August 14, 1982 (and no additional investment was made in the contract after August 13, 1982), the lump sum withdrawn is excludable from gross income as “an amount not received as an annuity” that is a return of principal received before the annuity starting date. Thus, the lump sum is subtracted from the unrecovered premium cost, and the balance is used as the investment in the contract. A new exclusion ratio ( Q 527) must be computed for the annuity payments.¹

If the lump sum withdrawn is allocable to investment in an annuity contract made after August 13, 1982, it would appear that there will be a taxable withdrawal of interest if the cash surrender value of the contract exceeds investment in the contract ( Q 515, Q 523) and a new exclusion ratio must be computed given a lower anticipated expected return due to the withdrawal of a portion of contract gains (paired with the existing investment in the contract that remains).

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1.     Treas. Reg. § 1.72-11(e).

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