540. How are variable annuity benefits payable under a qualified pension or profit sharing plan taxed to an employee?Nuco Employeercline202015-04-28T21:00:00Z2015-04-28T21:00:00Z38594897Summit Business Media4011574514Site Map/Retirement Plans/Pension And Profit Sharing/Taxation of Distributions/Participants and Beneficiaries/Distributions/Annuity Payments investment in contract annuity starting date basis simplified safe harbor 3-year cost recovery rule2005-01-24T00:00:00ZTaxFactsDefaultArticle116780441-00-tf1.xml443.00;#2270;#0x010100C568DB52D9D0A14D9B2FDCC96666E9F2007948130EC3DB064584E219954237AF3900242457EFB8B24247815D688C526CD44D009C4E67E972694125ABDA91AC61F5E51FTax Facts 1How are variable annuity benefits, payable under a qualified pension or profit sharing plan, taxed to an employee?128500.000000000TaxFactsDefaultArticle2010-01-15T00:59:43ZSBMEDIA\moss-admin540. How are variable annuity benefits payable under a qualified pension or profit sharing plan taxed to an employee?If an employee has no cost basis for an interest in a plan, each payment, regardless of amount, is fully taxable as ordinary income. An employee’s cost basis generally consists of any nondeductible contributions the employee has made to the plan and any employer contributions that have been taxed to the employee, other than excess deferrals (Q 3705) not timely distributed (Q 3864).When an employee has a cost basis for an interest in a plan and the annuity starting date is after June 30, 1986, payments are taxed under the annuity rules as expressly applied to variable payments (Q 476 to Q 478). Thus, the amount excludable from an employee’s gross income each year is determined by dividing the cost basis, adjusted for any refund or period-certain guarantee, by the number of years in the payment period. If an annuity is payable for a life or lives, the payment period is determined by the IRS annuity tables.For annuities with a starting date after December 31, 1986, the present value of any refund feature is not to be taken into account in calculating the unrecovered investment in the contract, but these amounts still are taken into account in calculating an individual’s exclusion ratio..IRC Sec. 72(b)(1),(2). The unrecovered investment in a contract affects only those annuitants who die before the annuity payments end (i.e., the amount of their deduction on their final year return) (Q 492) and the annuitant’s cost recovery date (i.e., the date upon which the annuity holder recovers his or her investment in the contract).Example. Mr. Mounger retired on August 31, 2015 when he had reached age sixty-five. He became eligible to receive monthly variable annuity payments for life under an earlier contributory pension plan of his employer. In the event of Mr. Mounger’s death before receiving payments for at least five years, payments on the same variable basis will be continued to his beneficiary for the remainder of the five year period. Mr. Mounger contributed $6,000 to the plan ($5,000 representing investment in the contract before July 1, 1986; $1,000 representing investment in the contract after June 30, 1986). Payments for the first year began in September, and during the last four months of the year, Mr. Mounger received a total of $640. Mr. Mounger elects to determine his excludable amount by making separate calculations for his pre-July 1986 and post-June 1986 investment in the contract. The value of the refund feature determined under Table VII of § 1.72-9 is not more than 50 percent, and Mr. Mounger had only life annuity options available. On the basis of these facts, Mr. Mounger’s annual exclusion from gross income will be $343.60. The first step is to adjust the investment in the contract for the value of the refund feature, as follows:Pre-July 1986 adjustment:Unadjusted investment in the contract$5,000Allocable part of amount to be received annually (($5,000 ÷ $6,000) x $1,920)$1,600Duration of guaranteed amount (years)5Guaranteed amount (5 x $1,600)$8,000Percentage in Table III for age 65 and 5 years7%Present value of refund feature rounded to nearest dollar (7% of $8,000)$ 560Adjusted pre-July 1986 investment in the contract ($5,000 - $560)$4,440Post-June 1986 adjustment:Unadjusted investment in the contract$1,000Allocable part of amount to be received annually (($1,000 ÷ $6,000) x $1,920)$ 320Duration of guaranteed amount (years)5Guaranteed amount (5 x $320)$1,600Percentage in Table VII for age 65 and 5 years3%Present value of refund feature rounded to nearest dollar (3% of $1,600)$ 48Adjusted post-June 1986 investment in the contract$ 952Once the investment in the contract has been adjusted by subtracting the value of the period-certain guarantee, an excludable amount is determined by dividing the adjusted investment in the contract by the life expectancy taken from Table I or V. Taking the example above, the excludable amount is determined as follows:Pre-July 1986 investment in the contract (adjusted for period-certain guarantee)$ 4,440Life expectancy from Table I (male age 65)15 yearsExcludable amount ($4,440 ÷ 15)$ 296 Post-June 1986 investment in the contract (adjusted for period-certain guarantee) $ 952Life expectancy from Table V (age 65)20 yearsExcludable amount ($952 ÷ 20)$ 47.60 Amount excludable from gross income each year ($296 + $47.60)$343.60In the case of an annuity starting date before November 19, 1996, a simplified safe harbor method may be available (Q 539.04).With respect to annuities with starting dates prior to July 1, 1986, payments are taxed under the annuity rules or under the three year cost recovery rule (Q 539.03).Certain early (premature) distributions are subject to an additional tax (Q 3860).