What happens to the interest earned if the annuitant dies before the payout start date?

• A. It is taxable
• B. It is tax-free
• C. It is returned to the policyholder
• D. It becomes cash value

Answer: (A)

Interest earned in a deferred annuity grows tax-deferred, but when distributions occur, the earnings portion is taxed as ordinary income. If the annuitant dies before the payout start date, the beneficiary receives the contract’s death benefit, which includes any interest earned. The earnings portion of that death benefit is taxable to the beneficiary, while the portion representing the original premiums (the cost basis) may be returned tax-free up to that basis. This reflects the general rule that annuity growth is not taxed as it accumulates, but becomes taxable when money is withdrawn or paid out.