Tax Facts

613 / How is an employee taxed on periodic retirement benefits under a qualified pension, annuity, or profit sharing plan if the annuity starting date is after December 31, 1997?

If an employee, whether a regular employee or a self-employed individual, has no cost basis for his or her interest in a plan, the full amount of each payment is taxable to the employee as ordinary income.1 If an employee has a cost basis for his or her interest in a plan, the payments are taxed as discussed below, depending on the employee’s annuity starting date. To determine an employee’s cost basis, see Q 3968.

The tax treatment is the same whether payment is made directly from a qualified trust or annuity plan or whether a trust buys an annuity and distributes it to an employee.2 Distribution of an annuity contract itself affects the tax on lump sum distributions ( Q 140). If an employee has a cost basis for his or her interest, payments are taxed as discussed below, depending on the annuity starting date.

For an employee who has a cost basis for his or her interest, and whose annuity starting date is after December 31, 1997, the investment in the contract is recovered according to one of two schedules set forth in the IRC. For purposes of this rule, the employee’s investment in the contract does not include any adjustment for a refund feature under the contract.3

These tables operate in the same manner as the simplified safe harbor announced in 1988.4 If an annuity is payable over one life, the payments will be taxed as described below for annuities with a starting date after November 18, 1996. If the annuity is payable over two or more lives, the excludable portion of each monthly payment is determined by dividing the employee’s investment in the contract by the number of anticipated payments, as follows:5

If the combined ages of the annuitants are

Number of payments

110 and under 410
111-120 360
121-130 310
131-140 260
141+ 210
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