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Pub. 939, General Rule for Pensions and Annuities 2008 Tax Year

Publication 939 - Main Contents

Table of Contents

General Information

Some of the terms used in this publication are defined in the following paragraphs.

  • A pension is generally a series of payments made to you after you retire from work. Pension payments are made regularly and are for past services with an employer.

  • An annuity is a series of payments under a contract. You can buy the contract alone or you can buy it with the help of your employer. Annuity payments are made regularly for more than one full year.

Types of pensions and annuities.   Particular types of pensions and annuities include:

  1. Fixed period annuities. You receive definite amounts at regular intervals for a definite length of time.

  2. Annuities for a single life. You receive definite amounts at regular intervals for life. The payments end at death.

  3. Joint and survivor annuities. The first annuitant receives a definite amount at regular intervals for life. After he or she dies, a second annuitant receives a definite amount at regular intervals for life. The amount paid to the second annuitant may or may not differ from the amount paid to the first annuitant.

  4. Variable annuities. You receive payments that may vary in amount for a definite length of time or for life. The amounts you receive may depend upon such variables as profits earned by the pension or annuity funds or cost-of-living indexes.

  5. Disability pensions. You are under minimum retirement age and receive payments because you retired on disability. If, at the time of your retirement, you were permanently and totally disabled, you may be eligible for the credit for the elderly or the disabled discussed in Publication 524.

If your annuity starting date is after November 18, 1996, the General Rule cannot be used for the following qualified plans.

  • A qualified employee plan is an employer's stock bonus, pension, or profit-sharing plan that is for the exclusive benefit of employees or their beneficiaries. This plan must meet Internal Revenue Code requirements. It qualifies for special tax benefits, including tax deferral for employer contributions and rollover distributions.

  • A qualified employee annuity is a retirement annuity purchased by an employer for an employee under a plan that meets Internal Revenue Code requirements.

  • A tax-sheltered annuity is a special annuity plan or contract purchased for an employee of a public school or tax-exempt organization.

The General Rule is used to figure the tax treatment of various types of pensions and annuities, including nonqualified employee plans. A nonqualified employee plan is an employer's plan that does not meet Internal Revenue Code requirements. It does not qualify for most of the tax benefits of a qualified plan.

Annuity worksheets.   The worksheets found near the end of the text of this publication may be useful to you in figuring the taxable part of your annuity.

Request for a ruling.   If you are unable to determine the income tax treatment of your pension or annuity, you may ask the Internal Revenue Service to figure the taxable part of your annuity payments. This is treated as a request for a ruling. See Requesting a Ruling on Taxation of Annuity near the end of this publication.

Withholding tax and estimated tax.   Your pension or annuity is subject to federal income tax withholding unless you choose not to have tax withheld. If you choose not to have tax withheld from your pension or annuity, or if you do not have enough income tax withheld, you may have to make estimated tax payments.

Taxation of Periodic Payments

This section explains how the periodic payments you receive under a pension or annuity plan are taxed under the General Rule. Periodic payments are amounts paid at regular intervals (such as weekly, monthly, or yearly) for a period of time greater than one year (such as for 15 years or for life). These payments are also known as amounts received as an annuity.

Tip

If you receive an amount from your plan that is a nonperiodic payment (amount not received as an annuity), see Taxation of Nonperiodic Payments in Publication 575.

In general, you can recover your net cost of the pension or annuity tax free over the period you are to receive the payments. The amount of each payment that is more than the part that represents your net cost is taxable. Under the General Rule, the part of each annuity payment that represents your net cost is in the same proportion that your investment in the contract is to your expected return. These terms are explained in the following discussions.

Investment in the Contract

In figuring how much of your pension or annuity is taxable under the General Rule, you must figure your investment in the contract.

First, find your net cost of the contract as of the annuity starting date (defined later). To find this amount, you must first figure the total premiums, contributions, or other amounts paid. This includes the amounts your employer contributed if you were required to include these amounts in income. It also includes amounts you actually contributed (except amounts for health and accident benefits and deductible voluntary employee contributions).

From this total cost you subtract:

  1. Any refunded premiums, rebates, dividends, or unrepaid loans (any of which were not included in your income) that you received by the later of the annuity starting date or the date on which you received your first payment.

  2. Any additional premiums paid for double indemnity or disability benefits.

  3. Any other tax-free amounts you received under the contract or plan before the later of the dates in (1).

The annuity starting date   is the later of the first day of the first period for which you receive payment under the contract or the date on which the obligation under the contract becomes fixed.

Example.

On January 1 you completed all your payments required under an annuity contract providing for monthly payments starting on August 1, for the period beginning July 1. The annuity starting date is July 1. This is the date you use in figuring your investment in the contract and your expected return (discussed later).

Adjustments

If any of the following items apply, adjust (add or subtract) your total cost to find your net cost.

Foreign employment.   If you worked abroad, your cost includes amounts contributed by your employer that were not includible in your gross income. The contributions that apply were made either:

  1. Before 1963 by your employer for that work, or

  2. After 1962 by your employer for that work if you performed the services under a plan that existed on March 12, 1962.

Death benefit exclusion.   If you are the beneficiary of a deceased employee (or former employee), who died before August 21, 1996, you may qualify for a death benefit exclusion of up to $5,000. The beneficiary of a deceased employee who died after August 20, 1996, will not qualify for the death benefit exclusion.

How to adjust your total cost.   If you are eligible, treat the amount of any allowable death benefit exclusion as additional cost paid by the employee. Add it to the cost or unrecovered cost of the annuity at the annuity starting date. See Example 3 under Computation Under General Rule for an illustration of the adjustment to the cost of the contract.

Free IRS help.   If you are eligible for this exclusion and need help computing the amount of the death benefit exclusion, see Requesting a Ruling on Taxation of Annuity, near the end of this publication.

Net cost.   Your total cost plus certain adjustments and minus other amounts already recovered before the annuity starting date is your net cost. This is the unrecovered investment in the contract as of the annuity starting date. If your annuity starting date is after 1986, this is the maximum amount that you may recover tax free under the contract.

Refund feature.   Adjustment for the value of the refund feature is only applicable when you report your pension or annuity under the General Rule. Your annuity contract has a refund feature if:

  1. The expected return ( discussed later) of an annuity depends entirely or partly on the life of one or more individuals,

  2. The contract provides that payments will be made to a beneficiary or the estate of an annuitant on or after the death of the annuitant if a stated amount or a stated number of payments has not been paid to the annuitant or annuitants before death, and

  3. The payments are a refund of the amount you paid for the annuity contract.

  If your annuity has a refund feature, you must reduce your net cost of the contract by the value of the refund feature (figured using Table III or VII at the end of this publication, also see How To Use Actuarial Tables, later) to find the investment in the contract.

Zero value of refund feature.   For a joint and survivor annuity, the value of the refund feature is zero if:

  1. Both annuitants are age 74 or younger,

  2. The payments are guaranteed for less than 2½ years, and

  3. The survivor's annuity is at least 50% of the first annuitant's annuity.

  For a single-life annuity without survivor benefit, the value of the refund feature is zero if:

  1. The payments are guaranteed for less than 2½ years, and

  2. The annuitant is:

    1. Age 57 or younger (if using the new (unisex) annuity tables),

    2. Age 42 or younger (if male and using the old annuity tables), or

    3. Age 47 or younger (if female and using the old annuity tables).

  If you do not meet these requirements, you will have to figure the value of the refund feature, as explained in the following discussion.

Examples.

The first example shows how to figure the value of the refund feature when there is only one beneficiary. Example 2 shows how to figure the value of the refund feature when the contract provides, in addition to a whole life annuity, one or more temporary life annuities for the lives of children. In both examples, the taxpayer elects to use Tables V through VIII. If you need the value of the refund feature for a joint and survivor annuity, write to the Internal Revenue Service as explained under Requesting a Ruling on Taxation of Annuity, near the end of this publication.

Example 1.

At age 65, Barbara bought for $21,053 an annuity with a refund feature. She will get $100 a month for life. Barbara's contract provides that if she does not live long enough to recover the full $21,053, similar payments will be made to her surviving beneficiary until a total of $21,053 has been paid under the contract. In this case, the contract cost and the total guaranteed return are the same ($21,053). Barbara's investment in the contract is figured as follows:

Net cost $21,053
Amount to be received annually $1,200  
Number of years for which payment is guaranteed ($21,053 divided by $1,200) 17.54  
Rounded to nearest whole number of years 18  
Percentage from Actuarial Table VII for age 65 with 18 years of guaranteed payments 15%  
Value of the refund feature (rounded to the nearest dollar)—15% of $21,053 3,158
Investment in the contract, adjusted for value of refund feature $17,895
     

If the total guaranteed return were less than the $21,053 net cost of the contract, Barbara would apply the appropriate percentage from the tables to the lesser amount. For example, if the contract guaranteed the $100 monthly payments for 17 years to Barbara's estate or beneficiary if she were to die before receiving all the payments for that period, the total guaranteed return would be $20,400 ($100 × 12 × 17 years). In this case, the value of the refund feature would be $2,856 (14% of $20,400) and Barbara's investment in the contract would be $18,197 ($21,053 minus $2,856) instead of $17,895.

Example 2.

John died while still employed. His widow, Eleanor, age 48, receives $171 a month for the rest of her life. John's son, Elmer, age 9, receives $50 a month until he reaches age 18. John's contributions to the retirement fund totaled $7,559.45, with interest on those contributions of $1,602.53. The guarantee or total refund feature of the contract is $9,161.98 ($7,559.45 plus $1,602.53).

The adjustment in the investment in the contract is figured as follows:

A) Expected return:*    
  1) Widow's expected return:    
    Annual annuity ($171 × 12) $2,052  
    Multiplied by factor from Table V    
    (nearest age 48) 34.9 $71,614.80
  2) Child's expected return:    
    Annual annuity ($50 × 12) $600  
    Multiplied by factor from    
    Table VIII (nearest age 9    
    for term of 9 years) 9.0 5,400.00
  3) Total expected return   $77,014.80
B) Adjustment for refund feature:    
  1) Contributions (net cost) $7,559.45
  2) Guaranteed amount (contributions of $7,559.45 plus interest of $1,602.53) $9,161.98
  3) Minus: Expected return under child's (temporary life) annuity (A(2)) 5,400.00
  4) Net guaranteed amount $3,761.98
  5) Multiple from Table VII (nearest age 48 for 2 years duration (recovery of $3,761.98 at $171 a month to nearest whole year)) 0%
  6) Adjustment required for value of refund feature rounded to the nearest whole dollar
(0% × $3,761.98, the smaller of B(3) or B(6)) 		0
*Expected return is the total amount you and other eligible annuitants can expect to receive under the contract. See the discussion of expected return, later in this publication.

Free IRS help.   If you need to request assistance to figure the value of the refund feature, see Requesting a Ruling on Taxation of Annuity, near the end of this publication.

Expected Return

Your expected return is the total amount you and other eligible annuitants can expect to receive under the contract. The following discussions explain how to figure the expected return with each type of annuity.

Tip

A person's age, for purposes of figuring the expected return, is the age at the birthday nearest to the annuity starting date.

Fixed period annuity.   If you will get annuity payments for a fixed number of years, without regard to your life expectancy, you must figure your expected return based on that fixed number of years. It is the total amount you will get beginning at the annuity starting date. You will receive specific periodic payments for a definite period of time, such as a fixed number of months (but not less than 13). To figure your expected return, multiply the fixed number of months for which payments are to be made by the amount of the payment specified for each period.

Single life annuity.   If you are to get annuity payments for the rest of your life, find your expected return as follows. You must multiply the amount of the annual payment by a multiple based on your life expectancy as of the annuity starting date. These multiples are set out in actuarial Tables I and V near the end of this publication (see How To Use Actuarial Tables, later).

  You may need to adjust these multiples if the payments are made quarterly, semiannually, or annually. See Adjustments to Tables I, II, V, VI, and VIA following Table I.

Example.

Henry bought an annuity contract that will give him an annuity of $500 a month for his life. If at the annuity starting date Henry's nearest birthday is 66, the expected return is figured as follows:

Annual payment ($500 × 12 months) $6,000
Multiple shown in Table V, age 66 × 19.2
Expected return $115,200

If the payments were to be made to Henry quarterly and the first payment was made one full month after the annuity starting date, Henry would adjust the 19.2 multiple by +.1. His expected return would then be $115,800 ($6,000 × 19.3).

Annuity for shorter of life or specified period.   With this type of annuity, you are to get annuity payments either for the rest of your life or until the end of a specified period, whichever period is shorter. To figure your expected return, multiply the amount of your annual payment by a multiple in Table IV or VIII for temporary life annuities. Find the proper multiple based on your sex (if using Table IV), your age at the annuity starting date, and the nearest whole number of years in the specified period.

Example.

Harriet purchased an annuity this year that will pay her $200 each month for five years or until she dies, whichever period is shorter. She was age 65 at her birthday nearest the annuity starting date. She figures the expected return as follows:

Annual payment ($200 × 12 months) $2,400
Multiple shown in Table VIII, age 65, 5-year term × 4.9
Expected return $11,760

Tip

She uses Table VIII (not Table IV) because all her contributions were made after June 30, 1986. See Special Elections, later.

Joint and survivor annuities.   If you have an annuity that pays you a periodic income for life and after your death provides an identical lifetime periodic income to your spouse (or some other person), you figure the expected return based on your combined life expectancies. To figure the expected return, multiply the annual payment by a multiple in Table II or VI based on your joint life expectancies. If your payments are made quarterly, semiannually, or annually, you may need to adjust these multiples. See Adjustments to Tables I, II, V, VI, and VIA following Table I near the end of this publication.

Example.

John bought a joint and survivor annuity providing payments of $500 a month for his life, and, after his death, $500 a month for the remainder of his wife's life. At John's annuity starting date, his age at his nearest birthday is 70 and his wife's at her nearest birthday is 67. The expected return is figured as follows:

Annual payment ($500 × 12 months) $6,000
Multiple shown in Table VI, ages 67 and 70 × 22.0
Expected return $132,000

Different payments to survivor.   If your contract provides that payments to a survivor annuitant will be different from the amount you receive, you must use a computation which accounts for both the joint lives of the annuitants and the life of the survivor.

Example 1.

Gerald bought a contract providing for payments to him of $500 a month for life and, after his death, payments to his wife, Mary, of $350 a month for life. If, at the annuity starting date, Gerald's nearest birthday is 70 and Mary's is 67, the expected return under the contract is figured as follows:

Combined multiple for Gerald and Mary, ages 70 and 67 (from Table VI)   22.0
Multiple for Gerald, age 70 (from Table V)   16.0
Difference: Multiple applicable to Mary   6.0
Gerald's annual payment ($500 × 12) $6,000  
Gerald's multiple 16.0  
Gerald's expected return   $96,000
Mary's annual payment ($350 × 12) $4,200  
Mary's multiple 6.0  
Mary's expected return   25,200
Total expected return under the contract   $121,200

Example 2.

Your husband died while still employed. Under the terms of his employer's retirement plan, you are entitled to get an immediate annuity of $400 a month for the rest of your life or until you remarry. Your daughters, Marie and Jean, are each entitled to immediate temporary life annuities of $150 a month until they reach age 18.

You were 50 years old at the annuity starting date. Marie was 16 and Jean was 14. Using the multiples shown in Tables V and VIII at the end of this publication, the total expected return on the annuity starting date is $169,680, figured as follows:

Widow, age 50 (multiple from Table V—33.1 × $4,800 annual payment) $158,880
Marie, age 16 for 2 years duration (multiple from Table VIII—2.0 × $1,800 annual payment) 3,600
Jean, age 14 for 4 years duration (multiple from Table VIII—4.0 × $1,800 annual payment) 7,200
Total expected return $169,680

No computation of expected return is made based on your husband's age at the date of death because he died before the annuity starting date.

Computation Under
the General Rule

Under the General Rule, you figure the taxable part of your annuity by using the following steps:

Step 1.   Figure the amount of your investment in the contract, including any adjustments for the refund feature and the death benefit exclusion, if applicable. See Death benefit exclusion, earlier.

Step 2.   Figure your expected return.

Step 3.   Divide Step 1 by Step 2 and round to three decimal places. This will give you the exclusion percentage.

Step 4.   Multiply the exclusion percentage by the first regular periodic payment. The result is the tax-free part of each pension or annuity payment.

  The tax-free part remains the same even if the total payment increases or you outlive the life expectancy factor used. If your annuity starting date is after 1986, the total amount of annuity income that is tax free over the years cannot exceed your net cost.

  Each annuitant applies the same exclusion percentage to his or her initial payment called for in the contract.

Step 5.   Multiply the tax-free part of each payment (step 4) by the number of payments received during the year. This will give you the tax-free part of the total payment for the year.

  
Tip

  In the first year of your annuity, your first payment or part of your first payment may be for a fraction of the payment period. This fractional amount is multiplied by your exclusion percentage to get the tax-free part.

Step 6.   Subtract the tax-free part from the total payment you received. The rest is the taxable part of your pension or annuity.

Example 1.

You purchased an annuity with an investment in the contract of $10,800. Under its terms, the annuity will pay you $100 a month for life. The multiple for your age (age 65) is 20.0 as shown in Table V. Your expected return is $24,000 (20 × 12 × $100). Your cost of $10,800, divided by your expected return of $24,000, equals 45.0%. This is the percentage you will not have to include in income.

Each year, until your net cost is recovered, $540 (45% of $1,200) will be tax free and you will include $660 ($1,200 - $540) in your income. If you had received only six payments of $100 ($600) during the year, your exclusion would have been $270 (45% of $100 × 6 payments).

Example 2.

Gerald bought a joint and survivor annuity. Gerald's investment in the contract is $62,712 and the expected return is $121,200. The exclusion percentage is 51.7% ($62,712 ÷ $121,200). Gerald will receive $500 a month ($6,000 a year). Each year, until his net cost is recovered, $3,102 (51.7% of his total payments received of $6,000) will be tax free and $2,898 ($6,000 - $3,102) will be included in his income. If Gerald dies, his wife will receive $350 a month ($4,200 a year). If Gerald had not recovered all of his net cost before his death, his wife will use the same exclusion percentage (51.7%). Each year, until the entire net cost is recovered, his wife will receive $2,171.40 (51.7% of her payments received of $4,200) tax free. She will include $2,028.60 ($4,200 - $2,171.40) in her income tax return.

Example 3.

Using the same facts as Example 2 under Different payments to survivor, you are to receive an annual annuity of $4,800 until you die or remarry. Your two daughters each receive annual annuities of $1,800 until they reach age 18. Your husband contributed $25,576 to the plan. You are eligible for the $5,000 death benefit exclusion because your husband died before August 21, 1996.

Adjusted Investment in the Contract

Contributions $25,576
Plus: Death benefit exclusion 5,000
Adjusted investment in the contract $30,576

The total expected return, as previously figured (in Example 2 under Different payments to survivor), is $169,680. The exclusion percentage of 18.0% ($30,576 ÷ $169,680) applies to the annuity payments you and each of your daughters receive. Each full year $864 (18.0% × $4,800) will be tax free to you, and you must include $3,936 in your income tax return. Each year, until age 18, $324 (18.0% × $1,800) of each of your daughters' payments will be tax free and each must include the balance, $1,476, as income on her own income tax return.

Part-year payments.   If you receive payments for only part of a year, apply the exclusion percentage to the first regular periodic payment, and multiply the result by the number of payments received during the year. If you received a fractional payment, follow Step 5, discussed earlier. This gives you the tax-free part of your total payment.

Example.

On September 28, Mary bought an annuity contract for $22,050 that will give her $125 a month for life, beginning October 30. The applicable multiple from Table V is 23.3 (age 61). Her expected return is $34,950 ($125 × 12 × 23.3). Mary's investment in the contract of $22,050, divided by her expected return of $34,950, equals 63.1%. Each payment received will consist of 63.1% return of cost and 36.9% taxable income, until her net cost of the contract is fully recovered. During the first year, Mary received three payments of $125, or $375, of which $236.63 (63.1% × $375) is a return of cost. The remaining $138.37 is included in income.

Increase in annuity payments.   The tax-free amount remains the same as the amount figured at the annuity starting date, even if the payment increases. All increases in the installment payments are fully taxable.

Example.

Joe's wife died while she was still employed and, as her beneficiary, he began receiving an annuity of $147 per month. In figuring the taxable part, Joe elects to use Tables V through VIII. The cost of the contract was $7,938, consisting of the sum of his wife's net contributions, adjusted for any refund feature. His expected return as of the annuity starting date is $35,280 (age 65, multiple of 20.0 × $1,764 annual payment). The exclusion percentage is $7,938 ÷ $35,280, or 22.5%. During the year he received 11 monthly payments of $147, or $1,617. Of this amount, 22.5% × $147 × 11 ($363.83) is tax free as a return of cost and the balance of $1,253.17 is taxable.

Later, because of a cost-of-living increase, his annuity payment was increased to $166 per month, or $1,992 a year (12 × $166). The tax-free part is still only 22.5% of the annuity payments as of the annuity starting date (22.5% × $147 × 12 = $396.90 for a full year). The increase of $228 ($1,992 - $1,764 (12 × $147)) is fully taxable.

Variable annuities.   For variable annuity payments, figure the amount of each payment that is tax free by dividing your investment in the contract (adjusted for any refund feature) by the total number of periodic payments you expect to get under the contract.

  If the annuity is for a definite period, you determine the total number of payments by multiplying the number of payments to be made each year by the number of years you will receive payments. If the annuity is for life, you determine the total number of payments by using a multiple from the appropriate actuarial table.

Example.

Frank purchased a variable annuity at age 65. The total cost of the contract was $12,000. The annuity starting date is January 1 of the year of purchase. His annuity will be paid, starting July 1, in variable annual installments for his life. The tax-free amount of each payment, until he has recovered his cost of his contract, is:

Investment in the contract $12,000
Number of expected annual payments (multiple for age 65 from Table V) 20
Tax-free amount of each payment ($12,000 ÷ 20) $600

If Frank's first payment is $920, he includes only $320 ($920 - $600) in his gross income.

  If the tax-free amount for a year is more than the payments you receive in that year, you may choose, when you receive the next payment, to refigure the tax-free part. Divide the amount of the periodic tax-free part that is more than the payment you received by the remaining number of payments you expect. The result is added to the previously figured periodic tax-free part. The sum is the amount of each future payment that will be tax free.

Example.

Using the facts of the previous example about Frank, assume that after Frank's $920 payment, he received $500 in the following year, and $1,200 in the year after that. Frank does not pay tax on the $500 (second year) payment because $600 of each annual pension payment is tax free. Since the $500 payment is less than the $600 annual tax-free amount, he may choose to refigure his tax-free part when he receives his $1,200 (third year) payment, as follows:

Amount tax free in second year $600.00
Amount received in second year 500.00
Difference $100.00
Number of remaining payments after the first 2 payments (age 67, from Table V) 18.4
Amount to be added to previously determined annual tax-free part ($100 ÷ 18.4) $5.43
Revised annual tax-free part for third and later years ($600 + $5.43) $605.43
Amount taxable in third year ($1,200 - $605.43) $594.57

If you choose to refigure your tax-free amount,   you must file a statement with your income tax return stating that you are refiguring the tax-free amount in accordance with the rules of section 1.72–4(d)(3) of the Income Tax Regulations. The statement must also show the following information:

  1. The annuity starting date and your age on that date.

  2. The first day of the first period for which you received an annuity payment in the current year.

  3. Your investment in the contract as originally figured.

  4. The total of all amounts received tax free under the annuity from the annuity starting date through the first day of the first period for which you received an annuity payment in the current tax year.

Exclusion Limits

Your annuity starting date determines the total amount of annuity income that you can exclude from income over the years.

Exclusion limited to net cost.   If your annuity starting date is after 1986, the total amount of annuity income that you can exclude over the years as a return of your cost cannot exceed your net cost (figured without any reduction for a refund feature). This is the unrecovered investment in the contract as of the annuity starting date.

  If your annuity starting date is after July 1, 1986, any unrecovered net cost at your (or last annuitant's) death is allowed as a miscellaneous itemized deduction on the final return of the decedent. This deduction is not subject to the 2%-of-adjusted-gross-income limit.

Example 1.

Your annuity starting date is after 1986. Your total cost is $12,500, and your net cost is $10,000, taking into account certain adjustments. There is no refund feature. Your monthly annuity payment is $833.33. Your exclusion ratio is 12% and you exclude $100 a month. Your exclusion ends after 100 months, when you have excluded your net cost of $10,000. Thereafter, your annuity payments are fully taxable.

Example 2.

The facts are the same as in Example 1, except that there is a refund feature, and you die after 5 years with no surviving annuitant. The adjustment for the refund feature is $1,000, so the investment in the contract is $9,000. The exclusion ratio is 10.8%, and your monthly exclusion is $90. After 5 years (60 months), you have recovered tax free only $5,400 ($90 x 60). An itemized deduction for the unrecovered net cost of $4,600 ($10,000 net cost minus $5,400) may be taken on your final income tax return. Your unrecovered investment is determined without regard to the refund feature adjustment, discussed earlier, under Adjustments.

Exclusion not limited to net cost.   If your annuity starting date was before 1987, you could continue to take your monthly exclusion for as long as you receive your annuity. If you choose a joint and survivor annuity, your survivor continues to take the survivor's exclusion figured as of the annuity starting date. The total exclusion may be more than your investment in the contract.

How To Use Actuarial Tables

In figuring, under the General Rule, the taxable part of your annuity payments that you are to get for the rest of your life (rather than for a fixed number of years), you must use one or more of the actuarial tables in this publication.

Unisex Annuity Tables

Effective July 1, 1986, the Internal Revenue Service adopted new annuity Tables V through VIII, in which your sex is not considered when determining the applicable factor. These tables correspond to the old Tables I through IV. In general, Tables V through VIII must be used if you made contributions to the retirement plan after June 30, 1986. If you made no contributions to the plan after June 30, 1986, generally you must use only Tables I through IV. However, if you received an annuity payment after June 30, 1986, you may elect to use Tables V through VIII (see Annuity received after June 30, 1986, later).

Special Elections

Although you generally must use Tables V through VIII if you made contributions to the retirement plan after June 30, 1986, and Tables I through IV if you made no contributions after June 30, 1986, you can make the following special elections to select which tables to use.

Contributions made both before July 1986 and after June 1986.   If you made contributions to the retirement plan both before July 1986 and after June 1986, you may elect to use Tables I through IV for the pre-July 1986 cost of the contract, and Tables V through VIII for the post-June 1986 cost. (See the examples below.)

  Making the election. Attach this statement to your income tax return for the first year in which you receive an annuity:

  “I elect to apply the provisions of paragraph (d) of section 1.72–6 of the Income Tax Regulations.”

  The statement must also include your name, address, social security number, and the amount of the pre-July 1986 investment in the contract.

  If your investment in the contract includes post-June 1986 contributions to the plan, and you do not make the election to use Tables I through IV and Tables V through VIII, then you can only use Tables V through VIII in figuring the taxable part of your annuity. You must also use Tables V through VIII if you are unable or do not wish to determine the portions of your contributions which were made before July 1, 1986, and after June 30, 1986.

  Advantages of election. In general, a lesser amount of each annual annuity payment is taxable if you separately figure your exclusion ratio for pre-July 1986 and post-June 1986 contributions.

  
Tip

  If you intend to make this election, save your records that substantiate your pre-July 1986 and post-June 1986 contributions. If the death benefit exclusion applies (see discussion, earlier), you do not have to apportion it between the pre-July 1986 and the post-June 1986 investment in the contract.

  The following examples illustrate the separate computations required if you elect to use Tables I through IV for your pre-July 1986 investment in the contract and Tables V through VIII for your post-June 1986 investment in the contract.

Example 1.

Bill, who is single, contributed $42,000 to the retirement plan and will receive an annual annuity of $24,000 for life. Payment of the $42,000 contribution is guaranteed under a refund feature. Bill is 55 years old as of the annuity starting date. For figuring the taxable part of Bill's annuity, he chose to make separate computations for his pre-July 1986 investment in the contract of $41,300, and for his post-June 1986 investment in the contract of $700.

      Pre-
July 1986 		  Post-
June 1986
A. Adjustment for refund feature      
  1) Net cost $41,300   $700
  2) Annual annuity—$24,000
($41,300/$42,000 × $24,000) 		$23,600    
  ($700/$42,000 × $24,000)     $400
  3) Guarantee under contract $41,300   $700
  4) No. of years payments
guaranteed (rounded), A(3) ÷ A(2) 		2   2
  5) Applicable percentage from
Tables III and VII 		1%   0%
  6) Adjustment for value of refund
feature, A(5) × smaller of A(1)
or A(3) 		$413   $0
B. Investment in the contract      
  1) Net cost $41,300   $700
  2) Minus: Amount in A(6) 413   0
  3) Investment in the contract $40,887   $700
C. Expected return      
  1) Annual annuity receivable $24,000   $24,000
  2) Multiples from Tables I and V 21.7   28.6
  3) Expected return, C(1) × C(2) $520,800   $686,400
D. Tax-free part of annuity      
  1) Exclusion ratio as decimal,
B(3) ÷ C(3) 		.079   .001
  2) Tax-free part, C(1) × D(1) $1,896   $24

The tax-free part of Bill's total annuity is $1,920 ($1,896 plus $24). The taxable part of his annuity is $22,080 ($24,000 minus $1,920). If the annuity starting date is after 1986, the exclusion over the years cannot exceed the net cost (figured without any reduction for a refund feature).

Example 2.

Al is age 62 at his nearest birthday to the annuity starting date. Al's wife is age 60 at her nearest birthday to the annuity starting date. The joint and survivor annuity pays $1,000 per month to Al for life, and $500 per month to Al's surviving wife after his death. The pre-July 1986 investment in the contract is $53,100 and the post-June 1986 investment in the contract is $7,000. Al makes the election described in Example 1.

For purposes of this example, assume the refund feature adjustment is zero. If an adjustment is required, IRS will figure the amount. See Requesting a Ruling on Taxation of Annuity near the end of this publication.

      Pre-
July 1986 		  Post-
June 1986
A. Adjustment for refund feature      
  1) Net cost $53,100   $7,000
  2) Annual annuity—$12,000
($53,100/$60,100 × $12,000) 		$10,602    
  ($7,000/$60,100 × $12,000)     $1,398
  3) Guaranteed under the contract $53,100   $7,000
  4) Number of years guaranteed,
rounded, A(3) ÷ A(2) 		5   5
  5) Applicable percentages 0%   0%
  6) Refund feature adjustment, A(5) × smaller of A(1) or A(3) 0   0
B. Investment in the contract      
  1) Net cost $53,100   $7,000
  2) Refund feature adjustment 0   0
  3) Investment in the contract adjusted for refund feature $53,100   $7,000
C. Expected return      
  1) Multiple for both annuitants from Tables II and VI 25.4   28.8
  2) Multiple for first annuitant from Tables I and V 16.9   22.5
  3) Multiple applicable to surviving annuitant, subtract C(2) from C(1) 8.5   6.3
  4) Annual annuity to surviving annuitant $6,000   $6,000
  5) Portion of expected return for surviving annuitant, C(4) × C(3) $51,000   $37,800
  6) Annual annuity to first annuitant $12,000   $12,000
  7) Plus: Portion of expected return for first annuitant, C(6) × C(2) $202,800   $270,000
  8) Expected return for both annuitants, C(5) + C(7) $253,800   $307,800
D. Tax-free part of annuity      
  1) Exclusion ratio as a decimal, B(3) ÷ C(8) .209   .023
  2) Retiree's tax-free part of annuity, C(6) × D(1) $2,508   $276
  3) Survivor's tax-free part of annuity, C(4) × D(1) $1,254   $138

The tax-free part of Al's total annuity is $2,784 ($2,508 + $276). The taxable part of his annuity is $9,216 ($12,000 - $2,784). The exclusion over the years cannot exceed the net cost of the contract (figured without any reduction for a refund feature) if the annuity starting date is after 1986.

After Al's death, his widow will apply the same exclusion percentages (20.9% and 2.3%) to her annual annuity of $6,000 to figure the tax-free part of her annuity.

Annuity received after June 30, 1986.   If you receive an annuity payment after June 30, 1986, (regardless of your annuity starting date), you may elect to treat the entire cost of the contract as post-June 1986 cost (even if you made no post-June 1986 contributions to the plan) and use Tables V through VIII. Once made, you cannot revoke the election, which will apply to all payments during the year and in any later year.

  Make the election by attaching the following statement to your income tax return.

  “I elect, under section 1.72–9 of the Income Tax Regulations, to treat my entire cost of the contract as a post-June 1986 cost of the plan.”

  The statement must also include your name, address, and social security number.

  You should also indicate you are making this election if you are unable or do not wish to determine the parts of your contributions which were made before July 1, 1986, and after June 30, 1986.

Disqualifying form of payment or settlement.   If your annuity starting date is after June 30, 1986, and the contract provides for a disqualifying form of payment or settlement, such as an option to receive a lump sum in full discharge of the obligation under the contract, the entire investment in the contract is treated as post-June 1986 investment in the contract. See regulations section 1.72–6(d)(3) for additional examples of disqualifying forms of payment or settlement. You can find the Income Tax Regulations in many libraries and at Internal Revenue Service Offices.

  
Worksheet I

Worksheet I

Worksheet II

Worksheet II

Actuarial Tables:

Actuarial Tables:

  

  

  

  

  

  

  

  

  

  

  

  

  

  

  

Requesting a Ruling on
Taxation of Annuity

If you are a retiree, or the survivor of an employee or retiree, you may ask the Internal Revenue Service to help you determine the taxation of your annuity. If you make this request, you are asking for a ruling.

User fee.   Under the law in effect at the time this publication went to print, the IRS must charge a user fee for all ruling requests. You should call the IRS for the proper fee.

Tip

A request solely for the value of the refund feature is not treated as a ruling request and requires no fee. Also, if your annuity starting date is before January 1, 1987, and your contract has a refund feature, you may request help to determine the value of the refund feature without requesting a ruling.

Envelope

Send your request to:


Internal Revenue Service
Commissioner: TE/GE
Attention: T:EP:RA
P. O. Box 27063
McPherson Station
Washington, DC 20038

The user fee is allowed as a miscellaneous itemized deduction, subject to the 2%-of-adjusted-gross-income limit.

When to make the request.   Please note that requests sent between February 1 and April 15 may experience some delay. We process requests in the order received, and we will reply to your request as soon as we can process it. If you do not receive your ruling by the required filing date, you may use Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return to get an extension of time to file.

Information you must furnish.   You must furnish the information listed below so the IRS can comply with your request. Failure to furnish the information will result in a delay in processing your request. Please send only copies of the following documents, as the IRS retains all material sent for its records:

  1. A letter explaining the question(s) you wish to have resolved or the information you need from the ruling.

  2. Copies of any documents showing distributions, annuity rates, and annuity options available to you.

  3. A copy of any Form 1099–R you received since your annuity began.

  4. A statement indicating whether you have filed your return for the year for which you are making the request. If you have requested an extension of time to file that return, please indicate the extension date.

  5. Your daytime phone number.

  6. Your current mailing address.

  7. A power of attorney if someone other than you, an attorney, a certified public accountant, or an enrolled agent is signing this request. Form 2848, Power of Attorney and Declaration of Representative, may be used for this purpose.

  8. A completed Tax Information Sheet (or facsimile) shown on the next page. Sign and date the Disclosure and Perjury Statement (or facsimile) at the end of the tax information sheet. This statement must be signed by the retiree or the survivor annuitant. It cannot be signed by a representative.

How To Get Tax Help

You can get help with unresolved tax issues, order free publications and forms, ask tax questions, and get more information from the IRS in several ways. By selecting the method that is best for you, you will have quick and easy access to tax help.

Contacting your Taxpayer Advocate.   If you have attempted to deal with an IRS problem unsuccessfully, you should contact your Taxpayer Advocate.

  The Taxpayer Advocate represents your interests and concerns within the IRS by protecting your rights and resolving problems that have not been fixed through normal channels. While Taxpayer Advocates cannot change the tax law or make a technical tax decision, they can clear up problems that resulted from previous contacts and ensure that your case is given a complete and impartial review.

  To contact your Taxpayer Advocate:

  • Call the Taxpayer Advocate at 1–877–777–4778.

  • Call, write, or fax the Taxpayer Advocate office in your area.

  • Call 1–800–829–4059 if you are a TTY/TDD user.

  For more information, see Publication 1546, The Taxpayer Advocate Service of the IRS.

Free tax services.   To find out what services are available, get Publication 910, Guide to Free Tax Services. It contains a list of free tax publications and an index of tax topics. It also describes other free tax information services, including tax education and assistance programs and a list of TeleTax topics.

Access by computer

Personal computer. With your personal computer and modem, you can access the IRS on the Internet at www.irs.gov. While visiting our web site, you can:

  • See answers to frequently asked tax questions or request help by e-mail.

  • Download forms and publications or search for forms and publications by topic or keyword.

  • Order IRS products on-line.

  • View forms that may be filled in electronically, print the completed form, and then save the form for recordkeeping.

  • View Internal Revenue Bulletins published in the last few years.

  • Search regulations and the Internal Revenue Code.

  • Receive our electronic newsletters on hot tax issues and news.

  • Learn about the benefits of filing electronically (IRS e-file).

  • Get information on starting and operating a small business.

You can also reach us with your computer using File Transfer Protocol at ftp.irs.gov.

Request information by fax

TaxFax Service. Using the phone attached to your fax machine, you can receive forms and instructions by calling 703–368–9694. Follow the directions from the prompts. When you order forms, enter the catalog number for the form you need. The items you request will be faxed to you.

For help with transmission problems, call the FedWorld Help Desk at 703–487–4608.

Request information by phone

Phone. Many services are available by phone.

  • Ordering forms, instructions, and publications. Call 1–800–829–3676 to order current and prior year forms, instructions, and publications.

  • Asking tax questions. Call the IRS with your tax questions at 1–800–829–1040.

  • Solving problems. Take advantage of Everyday Tax Solutions service by calling your local IRS office to set up an in-person appointment at your convenience. Check your local directory assistance or www.irs.gov for the numbers.

  • TTY/TDD equipment. If you have access to TTY/TDD equipment, call 1–800–829–4059 to ask tax questions or to order forms and publications.

  • TeleTax topics. Call 1–800–829–4477 to listen to pre-recorded messages covering various tax topics.


Evaluating the quality of our telephone services. To ensure that IRS representatives give accurate, courteous, and professional answers, we use several methods to evaluate the quality of our telephone services. One method is for a second IRS representative to sometimes listen in on or record telephone calls. Another is to ask some callers to complete a short survey at the end of the call.

Request most forms at post offices and libraries.

Walk-in. Many products and services are available on a walk-in basis.

  • Products. You can walk in to many post offices, libraries, and IRS offices to pick up certain forms, instructions, and publications. Some IRS offices, libraries, grocery stores, copy centers, city and county governments, credit unions, and office supply stores have an extensive collection of products available to print from a CD-ROM or photocopy from reproducible proofs. Also, some IRS offices and libraries have the Internal Revenue Code, regulations, Internal Revenue Bulletins, and Cumulative Bulletins available for research purposes.

  • Services. You can walk in to your local IRS office to ask tax questions or get help with a tax problem. Now you can set up an appointment by calling your local IRS office number and, at the prompt, leaving a message requesting Everyday Tax Solutions help. A representative will call you back within 2 business days to schedule an in-person appointment at your convenience.

Envelope

Mail. You can send your order for forms, instructions, and publications to the Distribution Center nearest to you and receive a response within 10 workdays after your request is received. Find the address that applies to your part of the country.

  • Western part of U.S.:
    Western Area Distribution Center
    Rancho Cordova, CA 95743–0001

  • Central part of U.S.:
    Central Area Distribution Center
    P.O. Box 8903
    Bloomington, IL 61702–8903

  • Eastern part of U.S. and foreign addresses:
    Eastern Area Distribution Center
    P.O. Box 85074
    Richmond, VA 23261–5074

Request information on CDROM

CD-ROM for tax products. You can order IRS Publication 1796, Federal Tax Products on CD-ROM, and obtain:

  • Current tax forms, instructions, and publications.

  • Prior-year tax forms and instructions.

  • Popular tax forms that may be filled in electronically, printed out for submission, and saved for recordkeeping.

  • Internal Revenue Bulletins.

The CD-ROM can be purchased from National Technical Information Service (NTIS) by calling 1–877–233–6767 or on the Internet at http://www.irs.gov/cdorders. The first release is available in early January and the final release is available in late February.

Request information on CDROM

CD-ROM for small businesses. IRS Publication 3207, Small Business Resource Guide, is a must for every small business owner or any taxpayer about to start a business. This handy, interactive CD contains all the business tax forms, instructions and publications needed to successfully manage a business. In addition, the CD provides an abundance of other helpful information, such as how to prepare a business plan, finding financing for your business, and much more. The design of the CD makes finding information easy and quick and incorporates file formats and browsers that can be run on virtually any desktop or laptop computer.

It is available in March. You can get a free copy by calling 1–800–829–3676 or by visiting the website at www.irs.gov/smallbiz.

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