What is the tax treatment of benefit payments for a non-qualified annuity?

The benefit payments from a non-qualified annuity are fully taxable as ordinary income when withdrawals are made. This taxation arises because non-qualified annuities are purchased with after-tax dollars, meaning that while the contributions made to the annuity are not tax-deductible, the growth that occurs within the annuity is tax-deferred.

When a policyholder eventually withdraws funds or receives payments from a non-qualified annuity, the entire amount received is considered income for tax purposes, given that it exceeds the amount of basis—the initial investment that was made with after-tax dollars. This means that the tax on withdrawals comes into play when distributions are made.

Other options like tax-free payments or tax-deferred treatment do not apply in this scenario since, unlike qualified plans, non-qualified annuities do not allow for tax-free withdrawals or tax-deferral upon payment. Instead, the entire benefit payment is taxed, reflecting the nature of how non-qualified annuities are treated by the Internal Revenue Service when distributions are made to the annuitant or beneficiary.