IRC Section 72 sets out the federal income tax rules for annuities and certain life insurance distributions, including how amounts received are divided between taxable income and non taxable return of basis. It defines the exclusion ratio for annuity payments, explains how withdrawals and loans from annuity contracts are taxed, and provides guidance on distributions from life insurance policies that are not modified endowment contracts. The section also interacts with other provisions governing premature distribution penalties and required minimum distributions. For advisors, understanding Section 72 is essential when recommending annuities for retirement income, explaining partial surrenders or 1035 exchanges, and clarifying how policy withdrawals will be taxed in clients' long term income plans.

In everyday practice, advisors rely on IRC Section 72 when illustrating how annuity income will be taxed over a client's lifetime. They explain that during the exclusion period, a portion of each payment is treated as a tax free return of principal, while the remaining portion is taxable earnings, until basis has been fully recovered. Section 72's rules also determine how non annuitized withdrawals from deferred annuities are taxed, generally on a last in, first out basis for non qualified contracts. For life insurance, Section 72 helps distinguish tax treatment between policies that are MECs and those that are not, affecting how loans and withdrawals are reported. Advisors incorporate these rules into retirement income strategies, comparing annuity payouts, systematic withdrawals, and policy loans across different products. By understanding Section 72, producers can set accurate expectations about after tax income, avoid unpleasant surprises, and position annuities and permanent life insurance as coordinated tools in long term planning.