General or Simplified General Rule Use For Pensions and Annuities
Below, find detailed information about the use of the IRS's general rule or the simplified general rule in regard to pensions and annuities.
Starting date after 1986 and before 11/19/1996:
These annuitants must use the General Rule unless the Simplified General Rule is elected., However, the total amount of income that can be excluded as return of capital can’t be more than the investment in the contract less the value of any refund feature. Thus, when the investment in the contract is used up, the annuity is fully taxable., Otherwise, computations are like those described above.
Starting date after 07/01/86 and before 01/01/87:
Recipients of such distributions must use the General Rule unless the Simplified General Rule, described above, is elected. Use the same procedures described in (1) above.
Starting date before 07/02/86:
For such distributions, the General Rule applied when cost was not recovered within 36 months (the old Three-Year Rule). First-year calculation of these annuities determines the AMOUNT RECEIVED during the year AND the investment in the contract. The expected return is computed as follows:
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If the term for the annuity is fixed (e.g., $200 a month for 30 years), multiply the payment amount specified for each period by the number of months to be paid per the contract (e.g., $200 x 12 months x 30 years);
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If the annuity is for life (of the taxpayer, taxpayer and spouse, or taxpayer and other beneficiary), use IRS annuity tables., The annuity factors found in the tables equate with the number of years the annuity is expected to be received., Multiply the factor by 12 months and the result by the monthly annuity amount (or the annuity factor times the amount received yearly). Portions of the annuity tables are reproduced in chapter 4.02, but Regs 1.72-9 and IRS Publication 939 contain the full text.
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Once you know the expected return, compute the EXCLUSION RATIO by dividing the investment in the contract by the expected return. This exclusion ratio (expressed as a percentage) is the tax-free amount., In later years, use the same exclusion ratio and apply it to the “annuity amount” (i.e., the original level of payments). Cost of living or other adjustments are fully taxable. The exclusion ratio doesn’t change no matter how long the annuitant lives or how much is actually excluded.