617 / What is the simplified safe harbor method that can be used to determine the tax treatment of periodic retirement benefits under an annuity with a starting date before November 19, 1996?

In the case of an annuity starting date before November 19, 1996, a simplified safe harbor method can be used if annuity payments depend on the life of the employee or the joint lives of the employee and a beneficiary. If an employee was age 75 or older when annuity payments commenced, this method could be used only if fewer than five years of payments were guaranteed.¹ Under this method, investment in the contract is the employee’s cost basis in the plan. No refund feature adjustment has to be made. Investment in the contract is divided by the total number of monthly annuity payments expected. This number is taken from the following table and is based on the employee’s age at the annuity starting date:

Age	Number of Payments
55 and under	300
56-60	260
61-65	240
66-70	170
71 and over	120

The same expected number of payments applies regardless of whether the employee is receiving a single life annuity or a joint and survivor annuity. The dollar amount excluded from each payment does not change, even if the amount of the payments increases or decreases.² If an annuity starting date is after December 31, 1986, annuity payments received after the investment in the contract is recovered are fully includable in income.

An employee makes the election to use the safe harbor method by reporting the taxable portion of the annuity payments received in the year, including the annuity starting date under that method, on the income tax return for that year and for succeeding years. An employee may change the method used to report the tax treatment of annuity payments (i.e., from the safe harbor method to the actual calculation of an exclusion ratio or vice versa) by filing an amended return for all open tax years, as long as the year containing the annuity starting date is an open year.³

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1. Notice 88-118, 1988-2 CB 450.