LIFO taxation, in the context of life insurance and annuities, refers to the last in first out tax treatment applied to distributions from modified endowment contracts and nonqualified annuities. Under LIFO rules, taxable earnings are deemed to be withdrawn before nontaxable basis, so withdrawals and certain loans are taxed as ordinary income until all gain has been recovered. Only after earnings are fully distributed does basis come out tax free. This is less favorable than the FIFO treatment available to distributions from non MEC life insurance policies, where basis is typically recovered first. Understanding LIFO taxation is critical when designing funding patterns and advising clients on how to access policy or annuity values.

In practice, advisors encounter LIFO taxation when clients request withdrawals from annuities or from life insurance policies that have MEC status. Carriers report the taxable portion of each distribution on Form 1099-R, often surprising clients who assumed basis would come out first. Advisors therefore educate clients upfront about how heavily funded policies can become MECs and how that affects loan and withdrawal taxation. When working with annuities, they explain that any distribution prior to age fifty nine and a half may also incur an additional ten percent penalty on taxable amounts. In some cases, advisors help clients reposition contracts through 1035 exchanges or restructuring strategies, while coordinating with tax professionals. By understanding LIFO taxation, producers can prevent unpleasant tax surprises, design funding strategies that match client objectives, and guide informed decisions about when and how to tap into insurance and annuity values.