Final answer:
The tax treatment of benefit payments from non-qualified annuities is based on the earnings portion of the payments, which are taxed as ordinary income, while the principal is not taxed again.
Step-by-step explanation:
The tax treatment of benefit payments for a non-qualified annuity can vary. The main answer to the student's question is that benefit payments are not always fully taxable nor are they tax-exempt after a certain age. Instead, benefit payments from non-qualified annuities are taxed as ordinary income to the extent that they exceed the investment in the contract. This means that the portion of the payment that represents a return of the after-tax amount invested is tax-free, while earnings on the investment are taxed.When a non-qualified annuity is annuitized for a stream of payments, these benefit payments are typically split into two components for tax purposes. The first component is the return of the principal, which is the amount the annuity owner has paid into the annuity with after-tax dollars. This part is not taxed again. The second component consists of investment gains, which are taxed at the annuity owner's regular income tax rate. Also, there's no requirement that benefit payments must begin at age 59 1/2 to avoid a penalty - that rule applies to qualified retirement plans like 401(k)s.Conclusion Therefore, the correct interpretation is that the taxable portion of a non-qualified annuity payment is dependent on the investment gains component of the distribution. It is not defined purely by age thresholds for taxation or for penalty-free withdrawals.