Annuities✓ Verified · outline & fact-checked · Sep 2026Difficulty 3/5
A beneficiary who receives the death proceeds of a deferred annuity chooses to receive the value over time under a settlement option instead of taking a lump sum. Under this arrangement:
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
If the beneficiary elects to receive annuity proceeds as periodic payments rather than a lump sum, the payments are taxed under the exclusion ratio: the portion of each payment representing the return of cost basis is tax-free, and the remaining portion representing earnings is taxable as ordinary income. This arrangement spreads the taxable gain over the payment stream rather than recognizing it all at once.
Why the other options are wrong
- B) Spreading the payments does not make the earnings tax-free; the gain portion remains taxable under the exclusion ratio.
- C) Annuity distributions are ordinary income, never capital gain.
- D) Tax on the full gain is triggered in the death year only if the beneficiary takes a lump sum; a settlement option defers recognition.
Memory hook
Beneficiary with a settlement option = exclusion ratio math: tax-free basis portion plus taxable earnings portion, every check.