Which of the following applies to distributions from nonqualified annuities?

Distributions from nonqualified annuities are taxed on a last-in-first-out (LIFO) basis. This means that the most recent contributions to the annuity contract are considered to be distributed first, and these contributions are usually viewed as investment return. Therefore, any earnings in the account are taxed as ordinary income when distributed before the principal.

The LIFO taxation method is designed to ensure that the gains from the investment are taxed before the original contributions. This taxation approach is particularly relevant for annuities that were funded with after-tax dollars, which makes the treatment of earnings crucial for understanding the overall tax liability when funds are withdrawn.

The other options do not accurately reflect how nonqualified annuities are taxed. Tax-free distributions are generally not applicable because any earnings are subject to taxation. FIFO would incorrectly imply that the contributions made first would be withdrawn and potentially taxed less favorably, which is not the case for nonqualified annuities. Lastly, stating that there are no tax implications ignores the tax obligations associated with the earnings portion of the withdrawals.