So in this video, we're gonna take a look at some detailed examples of how to

allocate between the basis and income portions of annuities.

First, let's take a look at David.

David is age 22 and he purchases an annuity for $100,000.

The annuity is not part of a qualified retirement plan.

David is to receive $1,000 per month for life.

How much of the annual annuity income is includible in his gross income?

What if David lives an additional 70 years from the annuity start date?

What if David dies 40 years after buying the annuity?

What is the eligible tax deduction amount on his final tax return?

First, how much of the annual annuity income is includable in gross income?

Here, we first need to calculate the exclusion amount that

David is receiving as a recovery of capital.

However, to do so, we need to know what

David's life expectancy is at the time he begins receiving annuity payments.

At age 22, David's life expectancy is 59.9, from the annuity start date.

This 59.9 multiple is taken from the actuarial table of life expectancies.

Therefore, the expected return is calculated as follows.

Our expected return equals the annual amount to be

paid multiplied by the number of years the payments will be received.

Here, the expected return is $12,000 a year times 59.9, which is $718,800.

This is his expected return.

The exclusion ratio is the investment of $100,000 divided

by the $718,800, or 13.9%.

Therefore, the exclusion amount equals 13.9% of the annual payments of the $12,000.

So we can take the 13.9% multiplied by the $12,000 to get

$1,669.45 per year is the amount that's excluded from his income.

So here the $1,669.45 is a non-taxable return on capital, and

the remaining piece, the $10,330.55,

is included in gross income during the first 59.9 years.

What if David lives an additional 70 years from the annuity start date?

Well, for the last 121.2 months,

so that's 70 years minus 59.9 years multiplied by 12,

the taxpayer will include the full $1,000 each month in gross income.

That is, income received after the life expectancy has been exceeded is all includible,

because by the 59.9th month,

the entire investment has been recovered.

There is no other capital to recover tax free.

Finally, what if David dies 40 years after buying the annuity?

What's the eligible tax deduction amount on his final tax return?

We need to calculate how much of the investment was recovered at the time of his death.

The amount not recovered will be the amount that's

deducted as a loss on his final tax return.

So first, we look at the cost of the annuity,

that's $100,000, and we need to subtract out the cost that was previously recovered.

Here, we have our exclusion ratio,

the $100,000 divided by 718,800,

and we multiply it by the annuity amount,

the $12,000 received per year, times the 40 years that he did receive these payments.

So here the cost that he recovered was $66,777.96.

Therefore the remaining piece,

the $33,222.04 was basis that was not recovered.

Therefore, he can take this amount as a loss on his final tax return.

Here's a second detailed example.

Goliath is age 66, and he receives an annuity distribution of $1,000

per month for life from a qualified retirement plan,

beginning in January of the current year.

The investment in the annuity is $84,000.

How much of the monthly annuity income is includable in gross income?

What does the excludable amount of each payment,

if Goliath lives to be 85 years old?

That is, he lives another 228 months from the annuity start date.

And what happens if Goliath dies at 76 years old?

That is, he recovered only 120 months worth of the annuity cost.

What's the eligible tax deduction in that case on his final tax return?

First, how much of the monthly annuity income is includable in gross income?

Here we'll use the simplified method because

the annuity income is being distributed from a qualified retirement plan.

Here we simply divide the investment amount

by the number of expected monthly payments for

a 66 year old to obtain the excludable portion of income payment per month.

Here we take $84,000 of the investment divided by 210 monthly payments from this exhibit.

And here we get $400 per month that's excludable.

Thus, the remaining amount, the $600 per month, is includable in Goliath's gross income.

Second, what is the excludable amount of

each payment if Goliath lives to be 85 years old?

That is, he lives another 228 months from the annuity start date.

Well Goliath was 66 when he began receiving

the annuity payments, and he was expected to live for 210 more months.

However, he outlives the life expectancy by 18 months, or 228 months minus 210 months.

Therefore starting with the 211th month,

Goliath includes the entire $1,000 in gross income for each of these last 18 months.

Finally, what happens if Goliath dies at 76 years old?

That is, he recovered only 120 months worth of the annuity cost?

What's the eligible tax deduction that he can claim on his final tax return?

Like before, we need to calculate how much of

the investment was recovered by the time of his death.

The amount not recovered can be deducted as a loss on his final tax return.

So here the cost of the contract,

the cost of the annuity, is $84,000.

The cost that he had previously received back that he had recovered is

$84,000 divided by 210 months multiplied by the 120 months that he recovered.

So here he recovered $48,000 of the initial $84,000 investment.

He did not recover the $36,000.

Here, the $36,000 will be deductible as a loss on Goliath's final tax return.

Hopefully, these examples help you identify how to

allocate the payment stream of an annuity between

the non-taxable return of capital basis portion and the taxable income portion.