Publication 575 - Pension And Annuity Income - 2002 Page 10
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34If you used the Three-Year Rule (which was repealed for
Fully Taxable Payments
annuities starting after July 1, 1986), your annuity pay-
ments are now fully taxable.
The pension or annuity payments that you receive are fully
taxable if you have no cost in the contract because:
Exclusion limit. Your annuity starting date determines
1) You did not pay anything or are not considered to
the total amount of annuity payments that you can exclude
have paid anything for your pension or annuity,
from income over the years.
2) Your employer did not withhold contributions from
Exclusion limited to cost. If your annuity starting date
your salary, or
is after 1986, the total amount of annuity income that you
can exclude over the years as a recovery of the cost
3) You got back all of your contributions tax free in prior
cannot exceed your total cost. Any unrecovered cost at
years (however, see Exclusion not limited to cost
your (or the last annuitant’s) death is allowed as a miscella-
under Partly Taxable Payments, later).
neous itemized deduction on the final return of the dece-
Report the total amount you got on line 16b, Form 1040,
dent. Th is deducti on i s not sub ject to the
or line 12b, Form 1040A. You should make no entry on line
2%-of-adjusted-gross-income limit.
16a, Form 1040, or line 12a, Form 1040A.
Example 1. Your annuity starting date is after 1986, and
Deductible voluntary employee contributions. Distri-
you exclude $100 a month under the Simplified Method.
butions you receive that are based on your accumulated
The total cost of your annuity is $12,000. Your exclusion
deductible voluntary employee contributions are generally
ends when you have recovered your cost tax free, that is,
fully taxable in the year distributed to you. Accumulated
after 10 years (120 months). After that, your annuity pay-
deductible voluntary employee contributions include net
ments are fully taxable.
earnings on the contributions. If distributed as part of a
lump sum, they do not qualify for the 10-year tax option or
Example 2. The facts are the same as in Example 1,
capital gain treatment.
except you die (with no surviving annuitant) after the eighth
year of retirement. You have recovered tax free only
Partly Taxable Payments
$9,600 (8 × $1,200) of your cost. An itemized deduction for
your unrecovered cost of $2,400 ($12,000 minus $9,600)
If you have a cost to recover from your pension or annuity
can be taken on your final return.
plan (see Cost (Investment in the Contract), earlier), you
Exclusion not limited to cost. If your annuity starting
can exclude part of each annuity payment from income as
date is before 1987, you can continue to take your monthly
a recovery of your cost. This tax-free part of the payment is
exclusion for as long as you receive your annuity. If you
figured when your annuity starts and remains the same
chose a joint and survivor annuity, your survivor can con-
each year, even if the amount of the payment changes.
tinue to take the survivor’s exclusion figured as of the
The rest of each payment is taxable.
annuity starting date. The total exclusion may be more
You figure the tax-free part of the payment using one of
than your cost.
the following methods.
•
Simplified Method. You generally must use this
Simplified Method
method if your annuity is paid under a qualified plan
(a qualified employee plan, a qualified employee an-
Under the Simplified Method, you figure the tax-free part of
nuity, or a tax-sheltered annuity plan or contract).
each annuity payment by dividing your cost by the total
You cannot use this method if your annuity is paid
number of anticipated monthly payments. For an annuity
under a nonqualified plan.
that is payable for the lives of the annuitants, this number is
•
General Rule. You must use this method if your
based on the annuitants’ ages on the annuity starting date
annuity is paid under a nonqualified plan. You gener-
and is determined from a table. For any other annuity, this
ally cannot use this method if your annuity is paid
number is the number of monthly annuity payments under
under a qualified plan.
the contract.
You determine which method to use when you first begin
Who must use the Simplified Method. You must use the
receiving your annuity, and you continue using it each year
Simplified Method if your annuity starting date is after
that you recover part of your cost.
November 18, 1996, and you meet both of the following
conditions.
Qualified plan annuity starting before November 19,
1996. If your annuity is paid under a qualified plan and
1) You receive your pension or annuity payments from
your annuity starting date (defined earlier under Cost (In-
any of the following plans.
vestment in the Contract)) is after July 1, 1986, and before
November 19, 1996, you could have chosen to use either
a) A qualified employee plan.
the Simplified Method or the General Rule. If your annuity
b) A qualified employee annuity.
starting date is before July 2, 1986, you use the General
Rule unless your annuity qualified for the Three-Year Rule.
c) A tax-sheltered annuity plan (403(b) plan).
Page 10
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