Certified Financial Consultant (CFC) Practice Exam

What happens to the interest of a nonqualified annuity if the owner dies before the starting date?

1. It goes to the state

2. It is taxable to the estate

3. It is non-taxable to the spouse

4. It is forfeited

The correct answer is: It is non-taxable to the spouse

In the case of a nonqualified annuity, the interest component becomes significant when considering the implications of the owner's death before the starting date of the annuity. If the owner dies before the annuity begins payout, the interest that has been accrued typically passes on to the designated beneficiary. If the beneficiary is a spouse, the rules are favorable. Specifically, when the owner dies and the beneficiary is the spouse, the annuity can be transferred to the surviving spouse without triggering immediate tax consequences. This means the interest is non-taxable upon transfer, allowing the surviving spouse to continue with the annuity under potentially beneficial terms. It’s important to understand that the interest would be considered taxable income only when withdrawals or distributions are made. The transfer of interest to the spouse allows for continued tax deferment, making it a more financially advantageous scenario compared to other situations where the beneficiary might not be a spouse. While other choices might deal with different beneficiary outcomes or situations like the interest becoming part of the estate, the specific context of the question—when the beneficiary is the spouse—clearly allows for non-taxability of the annuity interest at the owner's death.