The deferred fixed annuity is often an attractive tax deferred investment. All too attractive, or so it would seem, considering the legislative effort to chip away at the tax advantage.
Historically, withdrawals of funds from deferred annuities were taxed on a First In First Out (FIFO) basis. That meant owners could draw investments out tax-free. Not until cost was fully recovered would there have been tax imposed on withdrawals. The TEFRA rules changed all that. The “income first” or LIFO withdrawal meant that withdrawals were taxed as income to the extent of tax deferred earnings.
In addition, taxable withdrawals were made subject to an additional 10% penalty tax if allocable to an investment made within 10 years. The objective was to force the contract into something other than a short-term investment mode.
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