# Gifts, Life, Annuity lecture.pdf - TA 318 Annuities Life...

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TA 318 Annuities, Life Insurance and Gifts

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Key Code Sections § 72 Taxation of purchased annuities § 101 Taxation of life insurance proceeds, including those paid in the form of an annuity § 102 Gifts and transfers at death 2
Annuities § 72 An annuity is a contract between you and an insurance company. The insurer agrees to make periodic payments to you beginning immediately or at some future date in return for lump sum payment today. Types of annuities: Fixed for a fixed number of years Life payment tied to one or more lifetimes For our purposes, all annuities start immediately in the year of purchase 3

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Problem 1 On January 1, 20X1 Ann purchased an annuity for \$30,000. Under the annuity contract she will receive \$4,000 per year for 10 years. What are the tax consequences of her receipt of the first \$4,000 payment in 20X1? 4
Problem 1 (cont’d) Total payments will be \$40,000 over the life of the annuity. She paid \$30,000. She will have \$10,000 of income in total, but when does she report it? First \$10,000 received? Last \$10,000 received? Pro rata portion of each payment? 5

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Exclusion ratio § 72(b) A pro rata portion of each payment will be excluded from income determined by an exclusion ratio. Divide the amount paid to buy the annuity (\$30,000) by the total payments to be received over the life of the annuity (\$40,000) = 75% excluded Each \$4,000 payment will result in \$1,000 of income and \$3,000 recovery of purchase price Over 10 payments, will exclude \$30,000 (the purchase price) and include \$10,000 (the income portion) 6
Problem 2 On January 1, 20X1 Ann purchased an annuity for \$40,000. Ann is 60 years old at the time of the purchase. Under the annuity contract she will receive \$6,000 per year for her lifetime. What are the tax consequences of her receipt of the first \$6,000 payment in 20X1? 7

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Problem 2 (cont d) We know what Ann paid to purchase the annuity But we need to know how much Ann will receive in order to calculate the exclusion ratio What information is missing? 8
Problem 2 (cont d) Need to know how long Ann will live in order to calculate the expected total payment Use life expectancy tables provided by the Secretary § 72(c)(3)(A) For annuities based on one life use Treas. Reg. § 1.72-9 Table 5 9

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Problem 2 (cont d) A 60 year old is deemed to have a life expectancy of 24.2 years But if dies in 24.2 years will receive either 24 or 25 payments! Amount paid = \$40,000 Total amount to be received = \$6,000 x 24.2 years = \$145,200 Exclusion ratio = 40,000 ÷ 145,200 = 0.2754820936639118 . . . Where do we stop? 10
Ann s Exclusion Ratio Round to the nearest 1/10 th of 1% Treas. Reg. § 1.72-4(a)(2) Example 1 Exclusion ratio = 27.5% \$1,650 excluded from Year 1 payment Report \$4,350 of income 11

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Problem 3 Assuming the same facts as Problem 2, what are the tax consequences of her receipt of the 26 th annual \$6,000 payment? 12
Problem 3 (cont d) By the end of the 25 th year, Ann would have received more than was anticipated under the regulation s assumption of a 24.2 year life span.

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