An investor purchases a non-registered prescribed annuity for $100,000, paying $5,000 annually for 25 years. How is the income from this prescribed annuity taxed annually, compared to an accrual annuity?

Question: An investor purchases a non-registered prescribed annuity for $100,000, paying $5,000 annually for 25 years. How is the income from this prescribed annuity taxed annually, compared to an accrual annuity?

Answer options: ✅ "Each $5,000 payment from the prescribed annuity is treated as having an equal blend of principal and interest, resulting in a level taxable amount over its term, unlike accrual annuities where more interest is taxed early on."

• "The entire $5,000 payment from the prescribed annuity is considered taxable income, as the initial investment was made with after-tax dollars."
• "Only the principal portion of the $5,000 payment is taxable from a prescribed annuity, with the interest portion being tax-exempt after a certain period."
• "Prescribed annuities are fully tax-exempt until the initial investment amount has been returned, at which point all subsequent payments become fully taxable."

Correct answer: "Each $5,000 payment from the prescribed annuity is treated as having an equal blend of principal and interest, resulting in a level taxable amount over its term, unlike accrual annuities where more interest is taxed early on."

Explanation: Prescribed annuities offer a tax-deferral advantage by averaging the taxable interest component evenly over the annuity's term. In contrast, an accrual annuity would tax a larger portion of interest in the early years and less in later years, due to the declining principal balance. Both principal and interest are part of the payment, but the prescribed method normalizes the taxable portion.