Question: I was told by a bank manager years ago that interest works like this. First in, first out in regards to withdrawing funds from annuities. That is, if I had an annuity that had earned $15,000, and I wanted to withdraw money from it, technically the money I would first be withdrawing would be the interest earned which would be taxable.

So, my question is this: I have two different annuities with the bank, each having a different account number and each being a different type of annuity. At this time, one annuity has about $16,000 interest earned, the other about $9,000. When I close out the annuity with the $9,000 earned interest, will my taxable interest be only the $9,000 for that annuity or will they also include the interest of the other annuity that has a different account number?

Answer: We'll have to assume both contracts are "deferred annuity contracts," says John Olsen, co-author of The Advisor's Guide to Annuities and president of Olsen Annuity Education. "If either one were an 'immediate annuity' no withdrawals would generally be possible," he says.

It is vitally important that you specify the type of annuity contract you're talking about, says Olsen. "When you say 'each being a different type of annuity,' I assume that you mean 'each being a different type of deferred annuity contract.'"

According to Olsen, the tax rules for the two basic types of deferred annuities - fixed and variable -- are the same, but the rules for either type of immediate annuity are very different. "So, with that understanding - that both are deferred annuities - let's answer your question," says Olsen.

The tax rules regarding deferred annuity contracts are different for those purchased before Aug. 14, 1982, and those purchased after that date. In the earlier contracts, withdrawals are considered to come first from principal and, only when all principal has been withdrawn, will withdrawals be considered to come from interest. This, says Olsen, is often referred to as "principal first" or "first-in, first out" or "FIFO."

"This means that those earlier withdrawals -- from principal would be tax-free; only after all principal has been withdrawn, would withdrawals be taxable," he says. "For newer annuities, the rule is reversed."

Withdrawals for contracts issued after Aug. 13, 1982 are considered to come from interest first and, only after all interest is been distributed, will withdrawals be tax-free -- as a return of principal. This, Olsen says, is often referred to as "interest first" or "last in, first out" or "LIFO."

In both cases, when interest is withdrawn, Olsen says it is taxed as ordinary income and capital gains treatment is never available from any annuity contract, "qualified" or "non-qualified."

"Qualified" refers to annuity contracts purchased inside an IRA or employer-sponsored retirement plan; "non-qualified" refers to annuity contracts purchased with after-tax dollars. "I am assuming that both annuity contracts in your question are 'non-qualified,'" he says.

Bottom line: "The insurance company that issued the annuity can tell you what the taxable amount of your withdrawal will be, whether you withdraw just a portion of the annuity value or the entire account balance," says Olsen.

Got questions about the new tax law, Social Security, Medicare, retirement, investments, or money in general? Want to be considered for a Money Makeover? Email Robert.Powell@TheStreet.com. Kim McSheridan assisted with this report.

Question: I was told by a bank manager years ago that interest works like this. First in, first out in regards to withdrawing funds from annuities. That is, if I had an annuity that had earned $15,000, and I wanted to withdraw money from it, technically the money I would first be withdrawing would be the interest earned which would be taxable.

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