Amounts Received As An Annuity

<div class="Section1">If an annuity contract was purchased before August&nbsp;14, 1982 (and no additional investment was made in the contract after August&nbsp;13, 1982), the lump sum withdrawn is excludable from gross income as &ldquo;an amount not received as an annuity&rdquo; that is a return of principal received before the annuity starting date. Thus, the lump sum is subtracted from the unrecovered premium cost, and the balance is used as the investment in the contract. A new exclusion ratio ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="527">527</a>) must be computed for the annuity payments.<a href="#_ftn1" name="_ftnref1">¹</a><div class="Section1"><br /> <br /> If the lump sum withdrawn is allocable to investment in an annuity contract made after August&nbsp;13, 1982, it would appear that there will be a taxable withdrawal of interest if the cash surrender value of the contract exceeds investment in the contract ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="515">515</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="523">523</a>) and a new exclusion ratio must be computed given a lower anticipated expected return due to the withdrawal of a portion of contract gains (paired with the existing investment in the contract that remains).<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 1.72-11(e).<br /> <br /> </div></div><br />

<div class="Section1">The computation outlined in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="537">537</a> is for a straight life annuity (without a refund or period-certain guarantee). The exclusion ratio for a single life refund or period-certain guarantee is determined in the same way, but the investment in the contract first must be adjusted by subtracting the value of the refund or period-certain guarantee. The value of the refund or period-certain guarantee is computed by the following steps:<div class="Section1"><br /> <blockquote>(1)&nbsp;&nbsp;&nbsp;&nbsp; Determine the duration of the guaranteed amount (number of years necessary for the total guaranteed return to be fully paid). In the case of a period-certain life annuity, the duration of the guaranteed amount, in years, is known (e.g., 10, 15, or 20 &ldquo;years certain&rdquo;). To find the duration of the guaranteed amount, in years, for a cash or installment refund life annuity, divide the total guaranteed amount by the amount of one year&rsquo;s annuity payments, and round the quotient to the nearest whole number of years.<br /> <br /> (2)&nbsp;&nbsp;&nbsp;&nbsp; Find the factor in Table III or VII (whichever is applicable, depending on when the investment is made in the contract) under the whole number of years (as determined above) and the age and (if applicable) the sex of the annuitant. This Table III or Table VII factor is the&nbsp;percentage value of the refund or period-certain guarantee.<br /> <br /> (3)&nbsp;&nbsp;&nbsp;&nbsp; Apply the applicable Table III or Table VII&nbsp;percentage to the smaller of (a) the investment in the contract, or (b) the total guaranteed return under the contract. The result is the present value of the refund or period-certain guarantee.<br /> <br /> (4)&nbsp;&nbsp;&nbsp;&nbsp; Subtract the present value of the refund or period-certain guarantee from the investment in the contract. The remainder is the adjusted investment in the contract to be used in the exclusion ratio.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> <em>Example 3:</em> On January&nbsp;1, 2025, a husband, age 65, purchases for $21,053 an immediate installment refund annuity that pays $100 a month for life. The contract provides that in the event the husband does not live long enough to recover the full purchase price, payments will be made to his spouse until the total payments under the contract equal the purchase price. The investment in the contract is adjusted for the purpose of determining the exclusion ratio as follows:</blockquote><br /> <table border="1" align="center"><br /> <tbody><br /> <tr><br /> <td width="400">Unadjusted investment in the contract</td><br /> <td style="text-align: right;" width="67">$21,053</td><br /> </tr><br /> <tr><br /> <td width="400">Amount to be received annually</td><br /> <td style="text-align: right;" width="67">$1,200</td><br /> </tr><br /> <tr><br /> <td width="400">Duration of guaranteed amount ($21,053 &divide; $1,200)</td><br /> <td style="text-align: right;" width="67">17.5 yrs.</td><br /> </tr><br /> <tr><br /> <td width="400">Rounded to nearest whole number of years</td><br /> <td style="text-align: right;" width="67">18</td><br /> </tr><br /> <tr><br /> <td width="400">Percentage value of guaranteed refund (Table VII for age 65 and 18 years)</td><br /> <td style="text-align: right;" width="67">15%</td><br /> </tr><br /> <tr><br /> <td width="400">Value of refund feature rounded to nearest dollar (15% of $21,053)</td><br /> <td style="text-align: right;" width="67">$3,158</td><br /> </tr><br /> <tr><br /> <td width="400">Adjusted investment in the contract ($21,053 &ndash; $3,158)</td><br /> <td style="text-align: right;" width="67">$17,895</td><br /> </tr><br /> </tbody><br /> </table><br /> <blockquote><em>Example 4:</em> Assume the contract in Example 3 was purchased as a deferred annuity, the pre-July&nbsp;1986 investment in the contract is $10,000, and the post-June&nbsp;1986 investment in the contract is $11,053. If the annuitant elects to compute a separate exclusion&nbsp;percentage for the pre-July&nbsp;1986 and the post-June&nbsp;1986 amounts, separate computations must be performed to determine the adjusted investment in the contract. The pre-July&nbsp;1986 investment in the contract and the post-June&nbsp;1986 investment in the contract are adjusted for the purpose of determining the exclusion ratios in the following manner:</blockquote><br /> <table border="1" align="center"><br /> <tbody><br /> <tr><br /> <td colspan="3" width="470">Pre-July&nbsp;1986 adjustment:</td><br /> </tr><br /> <tr><br /> <td width="11"></td><br /> <td width="389">Unadjusted investment in the contract</td><br /> <td style="text-align: right;" width="69">$10,000</td><br /> </tr><br /> <tr><br /> <td width="11"></td><br /> <td width="389">Allocable part of amount to be received annually</td><br /> <td width="69"></td><br /> </tr><br /> <tr><br /> <td width="11"></td><br /> <td width="389">(($10,000 &divide; $21,053) &times; $1,200)</td><br /> <td style="text-align: right;" width="69">$570</td><br /> </tr><br /> <tr><br /> <td width="11"></td><br /> <td width="389">Duration of guaranteed amount ($10,000 &divide; $570)</td><br /> <td style="text-align: right;" width="69">17.5 yrs.</td><br /> </tr><br /> <tr><br /> <td width="11"></td><br /> <td width="389">Rounded to nearest whole number of years</td><br /> <td style="text-align: right;" width="69">18</td><br /> </tr><br /> <tr><br /> <td width="11"></td><br /> <td width="389">Percentage in Table III for age 65 and 18 years</td><br /> <td style="text-align: right;" width="69">30%</td><br /> </tr><br /> <tr><br /> <td width="11"></td><br /> <td width="389">Present value of refund feature rounded to nearest dollar</td><br /> <td width="69"></td><br /> </tr><br /> <tr><br /> <td width="11"></td><br /> <td width="389">(30% of $10,000)</td><br /> <td style="text-align: right;" width="69">$3,000</td><br /> </tr><br /> <tr><br /> <td width="11"></td><br /> <td width="389">Adjusted pre-July&nbsp;1986 investment in the contract ($10,000 &ndash; $3,000)</td><br /> <td style="text-align: right;" width="69">$7,000</td><br /> </tr><br /> <tr><br /> <td colspan="3" width="470">Post-June&nbsp;1986 adjustment:</td><br /> </tr><br /> <tr><br /> <td width="11"></td><br /> <td width="389">Unadjusted investment in the contract</td><br /> <td style="text-align: right;" width="69">$11,053</td><br /> </tr><br /> <tr><br /> <td width="11"></td><br /> <td width="389">Allocable part of amount to be received annually</td><br /> <td width="69"></td><br /> </tr><br /> <tr><br /> <td width="11"></td><br /> <td width="389">(($11,053 &divide; $21,053) &times; $1,200)</td><br /> <td style="text-align: right;" width="69">$630</td><br /> </tr><br /> <tr><br /> <td width="11"></td><br /> <td width="389">Duration of guaranteed amount ($11,053 &divide; $630)</td><br /> <td style="text-align: right;" width="69">17.5 yrs.</td><br /> </tr><br /> <tr><br /> <td width="11"></td><br /> <td width="389">Rounded to nearest whole number of years</td><br /> <td style="text-align: right;" width="69">18</td><br /> </tr><br /> <tr><br /> <td width="11"></td><br /> <td width="389">Percentage in Table VII for age 65 and 18 years</td><br /> <td style="text-align: right;" width="69">15%</td><br /> </tr><br /> <tr><br /> <td width="11"></td><br /> <td width="389">Present value of refund feature rounded to nearest dollar)</td><br /> <td width="69"></td><br /> </tr><br /> <tr><br /> <td width="11"></td><br /> <td width="389">(15% of $11,053)</td><br /> <td style="text-align: right;" width="69">$1,658</td><br /> </tr><br /> <tr><br /> <td width="11"></td><br /> <td width="389">Adjusted post-June&nbsp;1986 investment in the contract ($11,053 &ndash; $1,658)</td><br /> <td style="text-align: right;" width="69">$9,395</td><br /> </tr><br /> </tbody><br /> </table><br /> <blockquote>Once the investment in the contract has been adjusted by subtracting the value of the refund or period-certain guarantee, an exclusion ratio is determined in the same way as for a straight life annuity. The expected return is computed, then the adjusted investment in the contract is divided by expected return. Taking the two examples above, the exclusion ratio for each contract is determined as follows.<br /> <br /> <em>Example (3)</em> above.</blockquote><br /> <table border="1" align="center"><br /> <tbody><br /> <tr><br /> <td width="400">Investment in the contract (adjusted for refund guarantee)</td><br /> <td style="text-align: right;" width="67">$17,895</td><br /> </tr><br /> <tr><br /> <td width="400">One year&rsquo;s guaranteed annuity payments (12 &times; $100)</td><br /> <td style="text-align: right;" width="67">$1,200</td><br /> </tr><br /> <tr><br /> <td width="400">Life expectancy from Table V, age 65</td><br /> <td style="text-align: right;" width="67">20 yrs.</td><br /> </tr><br /> <tr><br /> <td width="400">Expected return (20 &times; $1,200)</td><br /> <td style="text-align: right;" width="67">$24,000</td><br /> </tr><br /> <tr><br /> <td width="400">Exclusion ratio ($17,895 &divide; $24,000)</td><br /> <td style="text-align: right;" width="67">74.6%</td><br /> </tr><br /> <tr><br /> <td width="400">Amount excludable from gross income each year in which 12</td><br /> <td width="67"></td><br /> </tr><br /> <tr><br /> <td width="400">payments are received (74.6% of $1,200)*</td><br /> <td style="text-align: right;" width="67">$895.20</td><br /> </tr><br /> <tr><br /> <td width="400">Amount includable in gross income ($1,200 &ndash; $895.20)*</td><br /> <td style="text-align: right;" width="67">$304.80</td><br /> </tr><br /> </tbody><br /> </table><br /> <blockquote>* Since the annuity starting date is after December&nbsp;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. However, if the annuity has a refund or guarantee feature, the value of the refund or guarantee feature is not subtracted when calculating the unrecovered investment.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> <em>Example (4)</em> above.</blockquote><br /> <table border="1" align="center"><br /> <tbody><br /> <tr><br /> <td width="400">Pre-July&nbsp;1986 investment in the contract (adjusted for period certain</td><br /> <td width="67"></td><br /> </tr><br /> <tr><br /> <td width="400">guarantee)</td><br /> <td style="text-align: right;" width="67">$7,000</td><br /> </tr><br /> <tr><br /> <td width="400">One year&rsquo;s guaranteed annuity payments (12 &times; $100)</td><br /> <td style="text-align: right;" width="67">$1,200</td><br /> </tr><br /> <tr><br /> <td width="400">Life expectancy from Table I, male age 65</td><br /> <td style="text-align: right;" width="67">15 yrs.</td><br /> </tr><br /> <tr><br /> <td width="400">Expected return (15 &times; $1,200)</td><br /> <td style="text-align: right;" width="67">$18,000</td><br /> </tr><br /> <tr><br /> <td width="400">Exclusion ratio ($7,000 &divide; $18,000)</td><br /> <td style="text-align: right;" width="67">38.9%</td><br /> </tr><br /> <tr><br /> <td colspan="2" width="467"></td><br /> </tr><br /> <tr><br /> <td width="400">Post-June&nbsp;1986 investment in the contract (adjusted for period certain</td><br /> <td width="67"></td><br /> </tr><br /> <tr><br /> <td width="400">guarantee)</td><br /> <td style="text-align: right;" width="67">$9,395</td><br /> </tr><br /> <tr><br /> <td width="400">One year&rsquo;s guaranteed annuity payments (12 &times; $100)</td><br /> <td style="text-align: right;" width="67">$1,200</td><br /> </tr><br /> <tr><br /> <td width="400">Life expectancy from Table V, age 65</td><br /> <td style="text-align: right;" width="67">20 yrs.</td><br /> </tr><br /> <tr><br /> <td width="400">Expected return (20 &times; $1,200)</td><br /> <td style="text-align: right;" width="67">$24,000</td><br /> </tr><br /> <tr><br /> <td width="400">Exclusion ratio ($9,395 &divide; $24,000)</td><br /> <td style="text-align: right;" width="67">39.1%</td><br /> </tr><br /> <tr><br /> <td width="400">Sum of pre-July and post-June&nbsp;1986 ratios</td><br /> <td style="text-align: right;" width="67">78%</td><br /> </tr><br /> <tr><br /> <td width="400">Amount excludable from gross income each year in which 12 payments</td><br /> <td width="67"></td><br /> </tr><br /> <tr><br /> <td width="400">are received (78% of $1,200)*</td><br /> <td style="text-align: right;" width="67">$936</td><br /> </tr><br /> <tr><br /> <td width="400">Amount includable in gross income ($1,200 &ndash; 936)*</td><br /> <td style="text-align: right;" width="67">$264</td><br /> </tr><br /> </tbody><br /> </table><br /> <blockquote>* Since the annuity starting date is after December&nbsp;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.</blockquote><br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 1.72-7(b).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 72(b)(4).<br /> <br /> </div></div><br />

<div class="Section1" style="text-align: center;"><strong>Non-Variable Contracts</strong><div class="Section1" style="text-align: left;"><br /> <br /> The basic annuity rule ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="527">527</a>) 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&nbsp;31, 1986, the exclusion ratio applies to payments received until the investment in the contract is recovered.<a href="#_ftn1" name="_ftnref1">¹</a> If the annuity starting date was before January&nbsp;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.<br /> <br /> The steps in the computation of the exclusion ratio are as follows:<br /> <blockquote>(1)&nbsp;&nbsp;&nbsp;&nbsp; Determine the investment in the contract ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="531">531</a>);<br /> <br /> (2)&nbsp;&nbsp;&nbsp;&nbsp; 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&rsquo;s guaranteed annuity payments by the applicable Table II or Table VI multiple. This is the expected return under the contract;<br /> <br /> (3)&nbsp;&nbsp;&nbsp;&nbsp; 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&nbsp;percentage (the &ldquo;exclusion&nbsp;percentage&rdquo;);<br /> <br /> (4)&nbsp;&nbsp;&nbsp;&nbsp; Apply the exclusion&nbsp;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.<br /> <br /> <em>Example</em>. After June&nbsp;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&rsquo;s age on his birthday nearest the annuity starting date is 65; Mrs. Black&rsquo;s, 63. The single premium is $22,000.</blockquote><br /> <table border="1" align="center"><br /> <tbody><br /> <tr><br /> <td width="400">Investment in the contract</td><br /> <td style="text-align: right;" width="67">$22,000</td><br /> </tr><br /> <tr><br /> <td width="400">One year&rsquo;s annuity payments (12 &times; $100)</td><br /> <td style="text-align: right;" width="67">$1,200</td><br /> </tr><br /> <tr><br /> <td width="400">Joint and survivor life expectancy multiple from Table VI (ages 65, 63)</td><br /> <td style="text-align: right;" width="67">26</td><br /> </tr><br /> <tr><br /> <td width="400">Expected return (26 &times; $1,200)</td><br /> <td style="text-align: right;" width="67">$31,200</td><br /> </tr><br /> <tr><br /> <td width="400">Exclusion ratio ($22,000 &divide; $31,200)</td><br /> <td style="text-align: right;" width="67">70.5%</td><br /> </tr><br /> <tr><br /> <td width="400">Amount excludable from gross income each year in which 12</td><br /> <td width="67"></td><br /> </tr><br /> <tr><br /> <td width="400">payments are received (70.5% of $1,200)*</td><br /> <td style="text-align: right;" width="67">$846</td><br /> </tr><br /> <tr><br /> <td width="400">Amount includable in gross income each year ($1,200 &ndash; $846)*</td><br /> <td style="text-align: right;" width="67">$354</td><br /> </tr><br /> </tbody><br /> </table><br /> <blockquote>* If the annuity starting date is after December&nbsp;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.</blockquote><br /> <p style="text-align: center;"><strong>Variable Contracts</strong></p><br /> The expected return, in Step 2 above, is the investment in the contract, divided by the payout period, as calculated above ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="550">550</a>).<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 72(b)(2).<br /> <br /> </div></div><br />

<div class="Section1">The survivor continues to exclude from gross income the same&nbsp;percentage of each payment that was excludable before the first annuitant&rsquo;s death. With respect to annuities having a starting date after December&nbsp;31, 1986, the total exclusion by the first annuitant and the survivor may not exceed the investment in the contract; that is, when the entire investment in the contract has been received tax-free, the entire amount of all subsequent payments will be taxed as ordinary income ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="540">540</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="543">543</a>). However, for annuities with starting dates prior to January&nbsp;1, 1987, the exclusion ratio continues to apply indefinitely to annuity payments, even if the amount of principal recovered exceeds the original investment in the contract.<div class="Section1"><br /> <br /> In addition, if the value of the survivor annuity was subject to estate tax, the survivor may be entitled to an income-in-respect-of-a-decedent income tax deduction for a portion of the estate tax paid (attributable to the embedded gain in the contract at the time of death).<a href="#_ftn1" name="_ftnref1">¹</a> This deduction, in most cases, will be small.<br /> <br /> Generally, the income-in-respect-of-a-decedent deduction is computed as follows: The portion of the guaranteed annual payment that will be excluded from the survivor&rsquo;s gross income (under the exclusion ratio) is multiplied by the survivor&rsquo;s life expectancy at the date of the first annuitant&rsquo;s death. The result is subtracted from the estate tax value of the survivor&rsquo;s annuity, thereby determining the amount of expected gain in the contract at death. The total income tax deduction allowable is the estate tax attributable to this remainder of the value of the survivor&rsquo;s annuity.<br /> <br /> This total deduction is claimed pro-rata over the survivor&rsquo;s life expectancy as of the date of the first annuitant&rsquo;s death, and a prorated amount is deductible from the survivor&rsquo;s gross income each year as payments are received. But no further deduction is allowable after the end of the survivor&rsquo;s life expectancy. The foregoing treatment applies only where the primary annuitant died after 1953.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong> Joint ownership of non-qualified annuities creates more problems than it solves, including forced distribution at either owner&rsquo;s death. Where the designated beneficiary of each owner is other than the other owner, payment, at either owner&rsquo;s death, generally will be made to that beneficiary, effectively (and surprisingly) &ldquo;disinheriting&rdquo; the surviving owner. Some annuity contracts contain language stating that if the contract is jointly owned (with a right of survivorship), the surviving owner will be deemed to be the deceased owner&rsquo;s primary beneficiary, notwithstanding any beneficiary designation to the contrary. Some insurers will not issue deferred annuities with joint ownership unless the owners are a married couple.<br /> <br /> It is worth noting that joint ownership often is unnecessary to achieve the objective that the policy owners may believe requires such ownership. For example, if a husband owns, and is the annuitant of, a deferred annuity of which his spouse is primary beneficiary, the death of either will leave the survivor in complete control of the contract. If the husband dies, the survivor, as the surviving spouse and primary beneficiary, may receive the death benefit or treat the contract as her own under IRC Section&nbsp;72(s)(3). If the spouse dies first, the husband remains in full control of the contract. <em>John L. Olsen, CLU, ChFC, AEP, Olsen Financial Group</em>.<br /> <br /> <hr><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 691(d).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 1.691(d)-1.<br /> <br /> </div></div><br />

<div class="Section1">Some joint and survivor annuities provide that the size of the annuity payment will decrease after the first death, regardless of which annuitant dies first (e.g., a joint and one-half or a joint and two-thirds survivor annuity). Rarely, the joint and survivor annuity will provide for increased payments after the first death. The exclusion ratio is determined in the usual way, by dividing the investment in the contract by the expected return under the contract ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="527">527</a>). However, expected return must be computed in the following manner:<a href="#_ftn1" name="_ftnref1">¹</a><div class="Section1"><br /> <blockquote>(1)&nbsp;&nbsp;&nbsp;&nbsp; Find the joint and survivor multiple in Table II or Table VI (depending on when the investment in the contract was made) under both annuitants&rsquo; ages and, if applicable, appropriate sexes. Multiply the amount of one year&rsquo;s annuity payments to the survivor by this Table II or Table VI multiple.<br /> <br /> (2)&nbsp;&nbsp;&nbsp;&nbsp; Find the joint life multiple in Table IIA or Table VIA (depending on when the investment in the contract was made) under both annuitants&rsquo; ages and, if applicable, appropriate sexes. Determine the difference between the amount of one year&rsquo;s annuity payments before the first death and the amount of one year&rsquo;s annuity payments after the first death. Multiply this difference in amount by the multiple from Table IIA or VIA, whichever is applicable.<br /> <br /> (3)&nbsp;&nbsp;&nbsp;&nbsp; If payments are to be smaller after the first death, the expected return is the sum of (1) and (2). If payments are to be larger after the first death, the expected return is the difference between (1) and (2).</blockquote><br /> After computing the expected return, determine the exclusion ratio under the basic annuity rule: divide the investment in the contract ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="531">531</a>) by the expected return under the contract (as computed above). This same exclusion ratio is applied to payments received before the first death and to payments received by the survivor. With respect to an annuity having a starting date after December&nbsp;31, 1986, the exclusion ratio is applied to payments only until the investment in the contract is recovered.<a href="#_ftn2" name="_ftnref2">²</a> However, in the case of an annuity with a starting date prior to January&nbsp;1, 1987, the exclusion ratio continues to apply to all payments made, regardless of whether investment in the contract has been fully recovered or not.<br /> <blockquote><em>Example 1</em>. After July&nbsp;30, 1986, Mr. and Mrs. Brown buy an immediate joint and survivor annuity that will provide monthly payments of $117 ($1,404 a year) for as long as both live, and monthly payments of $78 ($936 a year) to the survivor. As of the annuity starting date he is 65 years old; she is 63. The expected return is computed as follows.</blockquote><br /> <table border="1" align="center"><br /> <tbody><br /> <tr><br /> <td width="351">Joint and survivor multiple from Table VI (ages 65,63)</td><br /> <td style="text-align: right;" width="45">26</td><br /> <td width="84"></td><br /> </tr><br /> <tr><br /> <td colspan="2" width="396">Portion of expected return (26 &times; $936)</td><br /> <td style="text-align: right;" width="84">$24,336.00</td><br /> </tr><br /> <tr><br /> <td width="351">Joint life multiple from Table VIA (ages 65, 63)</td><br /> <td style="text-align: right;" width="45">15.6</td><br /> <td width="84"></td><br /> </tr><br /> <tr><br /> <td colspan="3" width="480">Difference between annual annuity payment before the first death</td><br /> </tr><br /> <tr><br /> <td width="351">and annual annuity payment to the survivor ($1,404 &ndash; $936)</td><br /> <td style="text-align: right;" width="45">$468</td><br /> <td width="84"></td><br /> </tr><br /> <tr><br /> <td colspan="2" width="396">Portion of expected return (15.6 &times; $468)</td><br /> <td style="text-align: right;" width="84">$7,300.80</td><br /> </tr><br /> <tr><br /> <td colspan="2" width="396">Expected return</td><br /> <td style="text-align: right;" width="84">$31,636.80</td><br /> </tr><br /> </tbody><br /> </table><br /> Assuming that the Browns paid $22,000 for the contract, the exclusion ratio is 69.5&nbsp;percent ($22,000 &divide; $31,636.80). During their joint lives the portion of each monthly payment to be excluded from gross income is $81.31 (69.5&nbsp;percent of $117), or $975.72 a year. The portion to be included is $35.69 ($117 &ndash; $81.31), or $428.28 a year. After the first death, the portion of each monthly payment to be excluded from gross income will be $54.21 (69.5&nbsp;percent of $78), or $650.52 a year. Of that monthly payment, $23.79 ($78 &ndash; $54.21), or $285.48 a year, will be included.<br /> <br /> As noted above, if the annuity starting date is after December&nbsp;31, 1986, the total amount excludable is limited to the investment in the contract. Thus, if Mr. Brown lives for 23 years, he may exclude $81.31 from each payment for 22 years ((12 &times; 22) &times; $81.31 = $21,465.84). In the next year, he may exclude $534.16 ($22,000 &ndash; $21,465.84) or $81.31 from each of the first six payments, but only $46.30 from the seventh. The balance is entirely includable in his income and on his death his widow must include the full amount of each payment in income.<br /> <blockquote><em>Example 2.</em> Assume that in the example above, there is a pre-July&nbsp;1986 investment in the contract of $12,000 and a post-June&nbsp;1986 investment in the contract of $10,000. Mr. Brown elects to calculate the exclusion&nbsp;percentage for each portion. The pre-July exclusion ratio would be 44.6&nbsp;percent ($12,000 &divide; $26,910, the expected return on the contract determined by using Tables II and IIA and the age and sex of both annuitants). The post-June&nbsp;1986 exclusion ratio is $10,000 &divide; $31,636.80 or 31.6&nbsp;percent. The amount excludable from each monthly payment while both are alive would be $89.15 (44.6&nbsp;percent of $117 plus 31.6&nbsp;percent of $117) and the remaining $27.85 would be included in gross income. If the annuity starting date is after December&nbsp;31, 1986, the total amount excludable is limited to the investment in the contract.</blockquote><br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 1.72-5(b)(5).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 72(b)(2).<br /> <br /> </div></div><br />

<div class="Section1" style="text-align: center;"><strong>Non-Variable Contracts</strong><div class="Section1"><br /> <br /> The basic annuity rule ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="527">527</a>) applies: Divide the investment in the contract ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="531">531</a>) by the expected return under the contract to determine the exclusion ratio for the payments. Apply this ratio to each payment to find the portion that is excludable from gross income. The balance of the payment is includable in gross income.<br /> <br /> If payments are for a fixed number of years (without regard to life expectancy), the expected return is the guaranteed amount receivable each year multiplied by the fixed number of years.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> If payments are for a fixed amount (without regard to life expectancy), the expected return is the total guaranteed amount of payments. Additional payments made after/beyond the guaranteed amount (due to excess interest) are fully taxable.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> To compute the excludable portion of each payment by a short method, divide the investment in the contract by the number of guaranteed payments. The result will never vary more than slightly from the exact computation.<br /> <blockquote><em>Example 1.</em> The owner of a maturing $25,000 endowment elects to receive the proceeds in equal annual payments of $2,785 for a fixed 10 year period. Assuming that the owner&rsquo;s investment in the contract is $22,500, the owner may exclude $2,250 ($22,500 &divide; 10) from gross income each year. The owner must include the balance of amounts received during the year in gross income.<br /> <br /> <em>Example 2.</em> The owner of a maturing $25,000 endowment elects to take the proceeds in monthly payments of $200. The company&rsquo;s rate book shows that payments of $200 are guaranteed for 144 months. Assuming that the owner&rsquo;s investment in the contract is $22,500, the owner can exclude $156.25 ($22,500 &divide; 144) of each payment from gross income, and must include $43.75 ($200 &ndash; $156.25). Thus, for a full 12 months of payments, the owner excludes $1,875 (12 &times; $156.25) and includes $525 ($2,400 &ndash; $1,875). Additional payments received after the 144 month period are fully taxable.</blockquote><br /> If the payee dies before the guaranteed period expires, the payee&rsquo;s beneficiary will exclude the same portion of each payment as originally computed.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> A penalty tax may be imposed on any payments received under the contract unless one of the exceptions listed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="523">523</a> is met.<br /> <p style="text-align: center;"><strong>Variable Contracts</strong></p><br /> Where the annuity payout is made under a variable basis (where the amount of each payment varies with the investment performance of the annuity &ldquo;separate accounts&rdquo;), the expected return is the investment in the contract ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="550">550</a>). The taxable amount of each annual payment will be the excess of the amount received in that year over the investment in the contract divided by the number of years in the period-certain.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 1.72-5(c).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 1.72-5(d).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 1.72-11(c)(2), Ex. 4.<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> The following steps are taken in applying the basic annuity rule to determine the portion of payments that may be excludable from income in the case of a straight life annuity:<br /> <blockquote>(1)&nbsp;&nbsp;&nbsp;&nbsp; Determine the investment in the contract ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="531">531</a>).<br /> <br /> (2)&nbsp;&nbsp;&nbsp;&nbsp; Find the life expectancy multiple in Table I or V, whichever is applicable for a person of the annuitant&rsquo;s age (and sex, if applicable). Multiply the sum of one year&rsquo;s guaranteed annuity payments by the applicable Table I or Table V multiple. For non-variable contracts, this is the expected return under the contract. For variable contracts, the &ldquo;expected return&rdquo; is the investment in the contract divided by the number of years over which payments will persist ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="550">550</a>).<br /> <br /> (3)&nbsp;&nbsp;&nbsp;&nbsp; Divide the investment in the contract by the expected return under the contract, carrying the quotient to three decimal places. This is the exclusion ratio expressed as a&nbsp;percentage (&ldquo;exclusion&nbsp;percentage&rdquo;).<br /> <br /> (4)&nbsp;&nbsp;&nbsp;&nbsp; Apply the exclusion&nbsp;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. If the annuity starting date is after December&nbsp;31, 1986, the exclusion&nbsp;percentage applies to payments received only until the investment in the contract is recovered. However, if the annuity starting date was before January&nbsp;1, 1987, the same exclusion&nbsp;percentage applies to all payments received throughout the annuitant&rsquo;s lifetime.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> <em>Example 1:</em> On October&nbsp;1, 2025, Mr. Brown purchased an immediate non-refund annuity that will pay him $125 a month ($1,500 a year) for life, beginning November&nbsp;1, 2025. He paid $16,000 for the contract. Mr. Brown&rsquo;s age on his birthday nearest the annuity starting date (October&nbsp;1) was 68. According to Table V (which he uses because his investment in the contract is post-June&nbsp;1986), his life expectancy is 17.6 years. Consequently, the expected return under the contract is $26,400 (12 &times; $125 &times; 17.6). The exclusion&nbsp;percentage for the annuity payments is 60.6&nbsp;percent ($16,000 &divide; $26,400). Because Mr. Brown received two monthly payments in 2025 (a total of $250), he will exclude $151.50 (60.6&nbsp;percent of $250) from his gross income for 2025, and he must include $98.50 ($250 &ndash; $151.50). Mr. Brown will exclude the amounts so determined for 17.6 years. In 2025, he could exclude $151.50; each year thereafter through 2041, he could exclude $909, for a total exclusion of $15,604.50 ($151.50 excluded in 2025 and $15,453 excluded over the next 17 years). In 2042, he could exclude only $395.50 ($16,000 &ndash; $15,604.50), which is all the investment in the contract he has left. In 2042, he would include in his income $1,104.50 ($1,500 &ndash; $395.50). In 2043 and each year thereafter, all cost basis has been recovered, and he would include $1,500 in income each year.<br /> <br /> <em>Example 2:</em> If Mr. Brown purchased the contract illustrated above on October&nbsp;1, 1986 (so that it had an annuity starting date before January&nbsp;1, 1987), he would exclude $151.50 (60.6&nbsp;percent of $250) from his 1986 gross income and would include $98.50 ($250 &ndash; $151.50). For each succeeding tax year in which he receives 12 monthly payments (even if he outlives his life expectancy of 17.6 years), he will exclude $909 (60.6&nbsp;percent of $1,500), and he will include $591 ($1,500 &ndash; $909), even after 17.6 years&rsquo; worth of payments have been made.</blockquote><br /> To calculate the excludable portion for an annuity contract with a refund or period-certain guarantee, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="538">538</a>.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 72(b)(2).<br /> <br /> </div></div><br />

<div class="Section1">A temporary life annuity is one that provides for fixed payments until the death of the annuitant or until the expiration of a specified number of years, whichever occurs earlier. The basic annuity rule ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="527">527</a>) applies. That is, 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 is determined by multiplying one year&rsquo;s annuity payments by the multiple in Table IV or Table VIII of the IRS Annuity Tables for the annuitant&rsquo;s age (as of the annuity starting date) and sex (if applicable) and the whole number of years in the specified period.<a href="#_ftn1" name="_ftnref1">¹</a> Tables IV and VIII can be found in Treasury Regulation Section&nbsp;1.72-9.<div class="Section1"><br /> <br /> The penalty tax of IRC Section&nbsp;72(q) may be imposed on the taxable portion of payments received under the contract unless one of the exceptions listed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="523">523</a> is met.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 1.72-5(a)(3).<br /> <br /> </div></div><br />

<div class="Section1">The exclusion ratio is determined as in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="540">540</a>, except that the investment in the contract first must be adjusted by subtracting the value of the refund or period-certain guarantee. This value is determined by following the steps below.<div class="Section1"><br /> <p style="text-align: center;"><strong>Investment in the Contract before July&nbsp;1986</strong></p><br /> If Table II is used to determine the expected return for pre-July&nbsp;1986 investment, the following method is used to determine the adjustment to the investment in the contract.<a href="#_ftn1" name="_ftnref1">¹</a> If Table VI is used to determine expected return for a pre-July&nbsp;1986 investment, investment in the contract is adjusted using the formula for post-July&nbsp;1986 investment (see subhead below).<a href="#_ftn2" name="_ftnref2">²</a><br /> <blockquote>(1)&nbsp;&nbsp;&nbsp;&nbsp; Determine the duration of the guaranteed amount (the number of years necessary for the guaranteed amount to be fully paid). In the case of a period-certain and life annuity, this is the number of years in the guaranteed period (e.g., 10, 15, or 20 &ldquo;years certain&rdquo;). To find the duration of the guaranteed amount, in years, for a cash or installment refund annuity, divide the total amount guaranteed under the contract by the amount of one year&rsquo;s annuity payments. Round the quotient to the nearest whole number of years.<br /> <br /> (2)&nbsp;&nbsp;&nbsp;&nbsp; If the annuitants are not of the same sex, substitute for a female a male five years younger (or for a male, a female five years older). Then find the refund&nbsp;percentage factors in Table III under the whole number of years, as determined in (1), and the age of each annuitant of the same sex. Add these two Table III factors.<br /> <br /> (3)&nbsp;&nbsp;&nbsp;&nbsp; Using ages of the same sex, as adjusted in (2), add to the age of the older annuitant the number of years indicated in the table below opposite the number of years by which the ages differ.</blockquote><br /> <table border="1" align="center"><br /> <tbody><br /> <tr><br /> <td width="314"><strong>Number of years difference in age (two male annuitants or two female annuitants)</strong></td><br /> <td style="text-align: center;" width="150"><strong>Addition to older age in years</strong></td><br /> </tr><br /> <tr><br /> <td width="314">0 to 1, inclusive</td><br /> <td style="text-align: center;" width="150">9</td><br /> </tr><br /> <tr><br /> <td width="314">2 to 3, inclusive</td><br /> <td style="text-align: center;" width="150">8</td><br /> </tr><br /> <tr><br /> <td width="314">4 to 5, inclusive</td><br /> <td style="text-align: center;" width="150">7</td><br /> </tr><br /> <tr><br /> <td width="314">6 to 8, inclusive</td><br /> <td style="text-align: center;" width="150">6</td><br /> </tr><br /> <tr><br /> <td width="314">9 to 11, inclusive</td><br /> <td style="text-align: center;" width="150">5</td><br /> </tr><br /> <tr><br /> <td width="314">12 to 15, inclusive</td><br /> <td style="text-align: center;" width="150">4</td><br /> </tr><br /> <tr><br /> <td width="314">16 to 20, inclusive</td><br /> <td style="text-align: center;" width="150">3</td><br /> </tr><br /> <tr><br /> <td width="314">21 to 27, inclusive</td><br /> <td style="text-align: center;" width="150">2</td><br /> </tr><br /> <tr><br /> <td width="314">28 to 42, inclusive</td><br /> <td style="text-align: center;" width="150">1</td><br /> </tr><br /> <tr><br /> <td width="314">Over 42</td><br /> <td style="text-align: center;" width="150">0</td><br /> </tr><br /> </tbody><br /> </table><br /> <blockquote>(4)&nbsp;&nbsp;&nbsp;&nbsp; Find the refund&nbsp;percentage factor in Table III under the whole number of years as determined in (1) and the age of the older annuitant as adjusted in (3).<br /> <br /> (5)&nbsp;&nbsp;&nbsp;&nbsp; Subtract the Table III factor found in (4) from the sum of the Table III factors found in (2). The balance, if any, is the&nbsp;percentage value of the refund or period-certain guarantee. If there is no balance, no adjustment in the investment in the contract need be made for the value of the refund or period-certain guarantee. If there is a balance, continue with the following steps.<br /> <br /> (6)&nbsp;&nbsp;&nbsp;&nbsp; Apply the&nbsp;percentage value of the refund or period-certain guarantee as determined in (5) to the smaller of the investment in the contract ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="531">531</a>) or the total guaranteed return under the contract. The result is the dollar value of the refund or period-certain guarantee.<br /> <br /> (7)&nbsp;&nbsp;&nbsp;&nbsp; Subtract the dollar value of the refund or period-certain guarantee from the investment in the contract. The remainder is the adjusted investment in the contract to be used in determining the exclusion ratio.<br /> <br /> <em>Example</em>. Mr. and Mrs. Green purchase an immediate joint and survivor annuity that will pay $200 a month for 10 years certain and as long thereafter as either is alive. Mr. Green is 70 years old as of his birthday nearest the annuity starting date. Mrs. Green is 65. The single premium is $35,000. The total guaranteed amount is $24,000.</blockquote><br /> <table border="1" align="center"><br /> <tbody><br /> <tr><br /> <td colspan="3" width="453">Investment in the contract (unadjusted)</td><br /> <td style="text-align: right;" width="55">$35,000</td><br /> </tr><br /> <tr><br /> <td colspan="2" width="407">Percentage factor from Table III for male, age 70, and 10-year guarantee</td><br /> <td style="text-align: right;" width="46">21%</td><br /> <td width="55"></td><br /> </tr><br /> <tr><br /> <td colspan="2" width="407">Percentage factor from Table III for male, age 60, and 10-year guarantee</td><br /> <td style="text-align: right;" width="46">11%</td><br /> <td width="55"></td><br /> </tr><br /> <tr><br /> <td colspan="2" width="407">Sum of percentage refund factors</td><br /> <td style="text-align: right;" width="46">32%</td><br /> <td width="55"></td><br /> </tr><br /> <tr><br /> <td width="361">Difference in years of age between two males, age 70 and 60</td><br /> <td style="text-align: right;" width="46">10</td><br /> <td colspan="2" width="101"></td><br /> </tr><br /> <tr><br /> <td width="361">Addition in years to older age (Table above)</td><br /> <td style="text-align: right;" width="46">5</td><br /> <td colspan="2" width="101"></td><br /> </tr><br /> <tr><br /> <td colspan="2" width="407">Percentage refund factor from Table III for male, age 75 and 10 year guarantee</td><br /> <td style="text-align: right;" width="46">29%</td><br /> <td width="55"></td><br /> </tr><br /> <tr><br /> <td colspan="2" width="407">Difference between percentages</td><br /> <td style="text-align: right;" width="46">3%</td><br /> <td width="55"></td><br /> </tr><br /> <tr><br /> <td colspan="3" width="453">Dollar value of period-certain guarantee (3% of $24,000)</td><br /> <td style="text-align: right;" width="55">720</td><br /> </tr><br /> <tr><br /> <td colspan="3" width="453">Adjusted investment in the contract</td><br /> <td style="text-align: right;" width="55">$34,280</td><br /> </tr><br /> <tr><br /> <td colspan="3" width="453">Table II multiple for male, age 70, and female, age 65</td><br /> <td style="text-align: right;" width="55">20.7</td><br /> </tr><br /> <tr><br /> <td colspan="3" width="453">Expected return (20.7 &times; $2,400)</td><br /> <td style="text-align: right;" width="55">$49,680</td><br /> </tr><br /> <tr><br /> <td colspan="3" width="453">Exclusion ratio ($34,280 &divide; $49,680)</td><br /> <td style="text-align: right;" width="55">69%</td><br /> </tr><br /> <tr><br /> <td colspan="3" width="453">Excludable from gross income each year (69% of $2,400)*</td><br /> <td style="text-align: right;" width="55">$1,656</td><br /> </tr><br /> <tr><br /> <td colspan="3" width="453">Includable in gross income each year ($2,400 &ndash; $1,656)*</td><br /> <td style="text-align: right;" width="55">$744</td><br /> </tr><br /> </tbody><br /> </table><br /> <blockquote>* If the annuity starting date is after December&nbsp;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.<a href="#_ftn3" name="_ftnref3">³</a> However, if the annuity has a refund or guarantee feature, the value of the refund or guarantee feature is not subtracted when calculating the unrecovered investment.<a href="#_ftn4" name="_ftnref4">⁴</a></blockquote><br /> <p style="text-align: center;"><strong>Investment in the Contract after June&nbsp;1986</strong></p><br /> Where the investment in a contract has been made after June&nbsp;30, 1986, IRS regulations provide a complex formula for determining the&nbsp;percentage factor that was developed for a pre-July&nbsp;1986 investment using the first five steps above. This&nbsp;percentage factor is then applied as explained in Steps 6 and 7 above.<a href="#_ftn5" name="_ftnref5">⁵</a> The IRS will determine the amount of the adjustment on request.<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 1.72-7(c)(2).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 1.72-7(c)(1).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 72(b)(4).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 72(c)-(d).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 1.72-7(c)(1)(i).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 1.72-7(c)(4).<br /> <br /> </div></div><br />

<div class="Section1">The beneficiary will have no taxable income until the total amount the beneficiary receives, when added to amounts that were received tax-free by the annuitant (i.e., the excludable portion of the annuity payments), exceeds the investment in the contract. In other words, all amounts received by the beneficiary under a refund guarantee are treated as a return of principal first, and are exempt from tax until the investment in the contract has been recovered tax-free. Thereafter, receipts (if any) are taxable income. For purposes of calculating the unrecovered investment in the contract, the value of the refund or guarantee feature is not subtracted.<a href="#_ftn1" name="_ftnref1">¹</a> This &ldquo;FIFO&rdquo; treatment, for payments made to the beneficiary, is different from the &ldquo;regular annuity rules&rdquo; treatment that applied to payments made to the deceased annuitant.<div class="Section1"><br /> <br /> The amount received by the beneficiary is considered paid in full discharge of the obligation under the contract in the nature of a refund of consideration and therefore comes under the cost recovery rule regardless of when the contract was entered into or when investments were made in the contract.<a href="#_ftn2" name="_ftnref2">²</a> This rule applies whether the refund is received in one sum or in installments made under the<em> same</em> payout arrangement under which the deceased annuitant had been receiving payments.<br /> <br /> If the refund or commuted value of remaining installments certain is applied anew under a <em>different</em> annuity option for the beneficiary, the payments will be taxed under the regular annuity rules. A new exclusion ratio will be determined for the beneficiary.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> If the refund beneficiary of an annuitant whose annuity starting date is after July&nbsp;1, 1986 does not recover the balance of the investment in the contract that was not recovered by the annuitant, the beneficiary may take a deduction for the unrecovered balance ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="567">567</a>).<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> Any payment made on or after the death of an annuity holder is not subject to the 10&nbsp;percent premature distribution tax ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="523">523</a>).<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 72(b)(4).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 72(e)(5); Treas. Reg. &sect;&sect; 1.72-11(a), 1.72-11(c).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 72(e)(5)(E); Treas. Reg. &sect;&sect; 1.72-11(c), 1.72-11(e).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp; &nbsp;&nbsp; IRC &sect; 72(b)(3).<br /> <br /> </div></div><br />