What tax implication is associated with a lump sum annuity if withdrawn before age 59 1/2?

A lump sum withdrawal from an annuity before reaching the age of 59 1/2 typically incurs a 10% premature distribution penalty, in addition to any applicable income taxes on the withdrawn amount. This is an important tax implication that the IRS imposes to discourage early withdrawals from retirement accounts, as those funds are intended for long-term saving and investment.

When funds are taken out early, not only can the individual be taxed at their ordinary income tax rate on the earnings portion of the annuity, but they also face this additional layer of penalty tax. Therefore, the correct answer highlights the significant financial consequence of withdrawing funds prematurely, reinforcing the importance of planning and understanding the long-term nature of retirement investments.

In contrast, options suggesting tax-free growth or no tax implications do not accurately reflect the reality of early withdrawals from annuities, while the capital gains tax option is not applicable in this scenario, as annuity distributions are typically taxed as ordinary income rather than capital gains.