540 / How can one calculate the excludable portion of payments under a joint and survivor annuity that continues distributing the same income to the survivor as was payable while both annuitants were alive?

The basic annuity rule ( Q 527) applies: the investment in the contract is divided by the expected return under the contract to find the portion of each payment that can be excluded from gross income (the exclusion ratio). Expected return must be computed by using a life expectancy multiple from Table II or Table VI of the IRS Annuity Tables. With respect to an annuity with a starting date after December 31, 1986, the exclusion ratio applies to payments received until the investment in the contract is recovered.¹ If the annuity starting date was before January 1, 1987, the exclusion ratio as originally computed applies to all payments received under the contract, including payments received by the survivor as well as those received while both annuitants were alive, even if the cost basis has been fully recovered.

The steps in the computation of the exclusion ratio are as follows:

(1)     Determine the investment in the contract ( Q 531);

(2)     Find the joint and survivor life expectancy multiple in Table II or Table VI (depending on when the investment in the contract was made) under the sexes (if applicable) and ages of the annuitants. Multiply one year’s guaranteed annuity payments by the applicable Table II or Table VI multiple. This is the expected return under the contract;

(3)     Divide the investment in the contract by the expected return, carrying the quotient to three decimal places. This is the exclusion ratio expressed as a percentage (the “exclusion percentage”);

(4)     Apply the exclusion percentage to the annuity payment. The result is the portion of the payment that is excludable from gross income. The balance of the payment must be included in gross income.

Example. After June 30, 1986, Mr. and Mrs. Black purchase an immediate joint and survivor annuity. The annuity will provide payments of $100 a month while both are alive and until the death of the survivor. Mr. Black’s age on his birthday nearest the annuity starting date is 65; Mrs. Black’s, 63. The single premium is $22,000.

Investment in the contract	$22,000
One year’s annuity payments (12 × $100)	$1,200
Joint and survivor life expectancy multiple from Table VI (ages 65, 63)	26
Expected return (26 × $1,200)	$31,200
Exclusion ratio ($22,000 ÷ $31,200)	70.5%
Amount excludable from gross income each year in which 12
payments are received (70.5% of $1,200)*	$846
Amount includable in gross income each year ($1,200 – $846)*	$354

* If the annuity starting date is after December 31, 1986, the total amount excludable is limited to the investment in the contract; after that has been recovered, the remaining amounts received are includable in income.

Variable Contracts

The expected return, in Step 2 above, is the investment in the contract, divided by the payout period, as calculated above ( Q 550).