§ 72. Annuities; certain proceeds of endowment and life insurance contracts
(a)
General rules for annuities
(1)
Income inclusion
Except as otherwise provided in this chapter, gross income includes any amount received as an annuity (whether for a period certain or during one or more lives) under an annuity, endowment, or life insurance contract.
(2)
Partial annuitization
If any amount is received as an annuity for a period of 10 years or more or during one or more lives under any portion of an annuity, endowment, or life insurance contract—
(b)
Exclusion ratio
(1)
In general
Gross income does not include that part of any amount received as an annuity under an annuity, endowment, or life insurance contract which bears the same ratio to such amount as the investment in the contract (as of the annuity starting date) bears to the expected return under the contract (as of such date).
(2)
Exclusion limited to investment
The portion of any amount received as an annuity which is excluded from gross income under paragraph (1) shall not exceed the unrecovered investment in the contract immediately before the receipt of such amount.
(3)
Deduction where annuity payments cease before entire investment recovered
(A)
In general
If—
(i)
after the annuity starting date, payments as an annuity under the contract cease by reason of the death of an annuitant, and
the amount of such unrecovered investment (in excess of any amount specified in subsection (e)(5) which was not included in gross income) shall be allowed as a deduction to the annuitant for his last taxable year.
(B)
Payments to other persons
In the case of any contract which provides for payments meeting the requirements of subparagraphs (B) and (C) of subsection (c)(2), the deduction under subparagraph (A) shall be allowed to the person entitled to such payments for the taxable year in which such payments are received.
(C)
Net operating loss deductions provided
For purposes of section
172, a deduction allowed under this paragraph shall be treated as if it were attributable to a trade or business of the taxpayer.
(c)
Definitions
(1)
Investment in the contract
For purposes of subsection (b), the investment in the contract as of the annuity starting date is—
(2)
Adjustment in investment where there is refund feature
If—
(A)
the expected return under the contract depends in whole or in part on the life expectancy of one or more individuals;
(B)
the contract provides for payments to be made to a beneficiary (or to the estate of an annuitant) on or after the death of the annuitant or annuitants; and
then the value (computed without discount for interest) of such payments on the annuity starting date shall be subtracted from the amount determined under paragraph (1). Such value shall be computed in accordance with actuarial tables prescribed by the Secretary. For purposes of this paragraph and of subsection (e)(2)(A), the term “refund of the consideration paid” includes amounts payable after the death of an annuitant by reason of a provision in the contract for a life annuity with minimum period of payments certain, but (if part of the consideration was contributed by an employer) does not include that part of any payment to a beneficiary (or to the estate of the annuitant) which is not attributable to the consideration paid by the employee for the contract as determined under paragraph (1)(A).
(3)
Expected return
For purposes of subsection (b), the expected return under the contract shall be determined as follows:
(4)
Annuity starting date
For purposes of this section, the annuity starting date in the case of any contract is the first day of the first period for which an amount is received as an annuity under the contract; except that if such date was before January 1, 1954, then the annuity starting date is January 1, 1954.
(d)
Special rules for qualified employer retirement plans
(1)
Simplified method of taxing annuity payments
(A)
In general
In the case of any amount received as an annuity under a qualified employer retirement plan—
(B)
Method of recovering investment in contract
(i)
In general
Gross income shall not include so much of any monthly annuity payment under a qualified employer retirement plan as does not exceed the amount obtained by dividing—
(ii)
Certain rules made applicable
Rules similar to the rules of paragraphs (2) and (3) of subsection (b) shall apply for purposes of this paragraph.
(iii)
Number of anticipated payments
If the annuity is payable over the life of a single individual, the number of anticipated payments shall be determined as follows:
If the age of the
annuitant on
The number
the annuity starting
of anticipated
date is:
payments is:
Not more than 55
360
More than 55 but not more than 60
310
More than 60 but not more than 65
260
More than 65 but not more than 70
210
More than 70
160.
(iv)
Number of anticipated payments where more than one life
If the annuity is payable over the lives of more than 1 individual, the number of anticipated payments shall be determined as follows:
If the combined ages of
annuitants are:
The number is:
Not more than 110
410
More than 110 but not more than 120
360
More than 120 but not more than 130
310
More than 130 but not more than 140
260
More than 140
210.
(C)
Adjustment for refund feature not applicable
For purposes of this paragraph, investment in the contract shall be determined under subsection (c)(1) without regard to subsection (c)(2).
(D)
Special rule where lump sum paid in connection with commencement of annuity payments
If, in connection with the commencement of annuity payments under any qualified employer retirement plan, the taxpayer receives a lump-sum payment—
(E)
Exception
This paragraph shall not apply in any case where the primary annuitant has attained age 75 on the annuity starting date unless there are fewer than 5 years of guaranteed payments under the annuity.
(e)
Amounts not received as annuities
(1)
Application of subsection
(3)
Allocation of amounts to income and investment
For purposes of paragraph (2)(B)—
(A)
Allocation to income
Any amount to which this subsection applies shall be treated as allocable to income on the contract to the extent that such amount does not exceed the excess (if any) of—
(4)
Special rules for application of paragraph (2)(B)
For purposes of paragraph (2)(B)—
(A)
Loans treated as distributions
If, during any taxable year, an individual—
(i)
receives (directly or indirectly) any amount as a loan under any contract to which this subsection applies, or
(ii)
assigns or pledges (or agrees to assign or pledge) any portion of the value of any such contract,
such amount or portion shall be treated as received under the contract as an amount not received as an annuity. The preceding sentence shall not apply for purposes of determining investment in the contract, except that the investment in the contract shall be increased by any amount included in gross income by reason of the amount treated as received under the preceding sentence.
(B)
Treatment of policyholder dividends
Any amount described in paragraph (1)(B) shall not be included in gross income under paragraph (2)(B)(i) to the extent such amount is retained by the insurer as a premium or other consideration paid for the contract.
(C)
Treatment of transfers without adequate consideration
(i)
In general
If an individual who holds an annuity contract transfers it without full and adequate consideration, such individual shall be treated as receiving an amount equal to the excess of—
under the contract as an amount not received as an annuity.
(5)
Retention of existing rules in certain cases
(A)
In general
In any case to which this paragraph applies—
the amount shall be included in gross income, but only to the extent it exceeds the investment in the contract.
(B)
Existing contracts
This paragraph shall apply to contracts entered into before August 14, 1982. Any amount allocable to investment in the contract after August 13, 1982, shall be treated as from a contract entered into after such date.
(C)
Certain life insurance and endowment contracts
Except as provided in paragraph (10) and except to the extent prescribed by the Secretary by regulations, this paragraph shall apply to any amount not received as an annuity which is received under a life insurance or endowment contract.
(D)
Contracts under qualified plans
Except as provided in paragraph (8), this paragraph shall apply to any amount received—
(E)
Full refunds, surrenders, redemptions, and maturities
This paragraph shall apply to—
(i)
any amount received, whether in a single sum or otherwise, under a contract in full discharge of the obligation under the contract which is in the nature of a refund of the consideration paid for the contract, and
In the case of any amount to which the preceding sentence applies, the rule of paragraph (2)(A) shall not apply.
(6)
Investment in the contract
For purposes of this subsection, the investment in the contract as of any date is—
(8)
Extension of paragraph (2)(b) 1 to qualified plans
(A)
In general
Notwithstanding any other provision of this subsection, in the case of any amount received before the annuity starting date from a trust or contract described in paragraph (5)(D), paragraph (2)(B) shall apply to such amounts.
(B)
Allocation of amount received
For purposes of paragraph (2)(B), the amount allocated to the investment in the contract shall be the portion of the amount described in subparagraph (A) which bears the same ratio to such amount as the investment in the contract bears to the account balance. The determination under the preceding sentence shall be made as of the time of the distribution or at such other time as the Secretary may prescribe.
(C)
Treatment of forfeitable rights
If an employee does not have a nonforfeitable right to any amount under any trust or contract to which subparagraph (A) applies, such amount shall not be treated as part of the account balance.
(D)
Investment in the contract before 1987
In the case of a plan which on May 5, 1986, permitted withdrawal of any employee contributions before separation from service, subparagraph (A) shall apply only to the extent that amounts received before the annuity starting date (when increased by amounts previously received under the contract after December 31, 1986) exceed the investment in the contract as of December 31, 1986.
(9)
Extension of paragraph (2)(B) to qualified tuition programs and Coverdell education savings accounts
Notwithstanding any other provision of this subsection, paragraph (2)(B) shall apply to amounts received under a qualified tuition program (as defined in section
529
(b)) or under a Coverdell education savings account (as defined in section
530
(b)). The rule of paragraph (8)(B) shall apply for purposes of this paragraph.
(10)
Treatment of modified endowment contracts
(A)
In general
Notwithstanding paragraph (5)(C), in the case of any modified endowment contract (as defined in section
7702A)—
(B)
Treatment of certain burial contracts
Notwithstanding subparagraph (A), paragraph (4)(A) shall not apply to any assignment (or pledge) of a modified endowment contract if such assignment (or pledge) is solely to cover the payment of expenses referred to in section
7702
(e)(2)(C)(iii) and if the maximum death benefit under such contract does not exceed $25,000.
(11)
Special rules for certain combination contracts providing long-term care insurance
Notwithstanding paragraphs (2), (5)(C), and (10), in the case of any charge against the cash value of an annuity contract or the cash surrender value of a life insurance contract made as payment for coverage under a qualified long-term care insurance contract which is part of or a rider on such annuity or life insurance contract—
(12)
Anti-abuse rules
(A)
In general
For purposes of determining the amount includible in gross income under this subsection—
(i)
all modified endowment contracts issued by the same company to the same policyholder during any calendar year shall be treated as 1 modified endowment contract, and
(ii)
all annuity contracts issued by the same company to the same policyholder during any calendar year shall be treated as 1 annuity contract.
The preceding sentence shall not apply to any contract described in paragraph (5)(D).
(f)
Special rules for computing employees’ contributions
In computing, for purposes of subsection (c)(1)(A), the aggregate amount of premiums or other consideration paid for the contract, and for purposes of subsection (e)(6), the aggregate premiums or other consideration paid, amounts contributed by the employer shall be included, but only to the extent that—
(1)
such amounts were includible in the gross income of the employee under this subtitle or prior income tax laws; or
(2)
if such amounts had been paid directly to the employee at the time they were contributed, they would not have been includible in the gross income of the employee under the law applicable at the time of such contribution.
Paragraph (2) shall not apply to amounts which were contributed by the employer after December 31, 1962, and which would not have been includible in the gross income of the employee by reason of the application of section
911 if such amounts had been paid directly to the employee at the time of contribution. The preceding sentence shall not apply to amounts which were contributed by the employer, as determined under regulations prescribed by the Secretary, to provide pension or annuity credits, to the extent such credits are attributable to services performed before January 1, 1963, and are provided pursuant to pension or annuity plan provisions in existence on March 12, 1962, and on that date applicable to such services, or to the extent such credits are attributable to services performed as a foreign missionary (within the meaning of section
403
(b)(2)(D)(iii), as in effect before the enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001).
(g)
Rules for transferee where transfer was for value
Where any contract (or any interest therein) is transferred (by assignment or otherwise) for a valuable consideration, to the extent that the contract (or interest therein) does not, in the hands of the transferee, have a basis which is determined by reference to the basis in the hands of the transferor, then—
(1)
for purposes of this section, only the actual value of such consideration, plus the amount of the premiums and other consideration paid by the transferee after the transfer, shall be taken into account in computing the aggregate amount of the premiums or other consideration paid for the contract;
(2)
for purposes of subsection (c)(1)(B), there shall be taken into account only the aggregate amount received under the contract by the transferee before the annuity starting date, to the extent that such amount was excludable from gross income under this subtitle or prior income tax laws; and
(3)
the annuity starting date is January 1, 1954, or the first day of the first period for which the transferee received an amount under the contract as an annuity, whichever is the later.
For purposes of this subsection, the term “transferee” includes a beneficiary of, or the estate of, the transferee.
(h)
Option to receive annuity in lieu of lump sum
If—
(1)
a contract provides for payment of a lump sum in full discharge of an obligation under the contract, subject to an option to receive an annuity in lieu of such lump sum;
(2)
the option is exercised within 60 days after the day on which such lump sum first became payable; and
(3)
part or all of such lump sum would (but for this subsection) be includible in gross income by reason of subsection (e)(1),
then, for purposes of this subtitle, no part of such lump sum shall be considered as includible in gross income at the time such lump sum first became payable.
(j)
Interest
Notwithstanding any other provision of this section, if any amount is held under an agreement to pay interest thereon, the interest payments shall be included in gross income.
(m)
Special rules applicable to employee annuities and distributions under employee plans
(2)
Computation of consideration paid by the employee
In computing—
(A)
the aggregate amount of premiums or other consideration paid for the contract for purposes of subsection (c)(1)(A) (relating to the investment in the contract), and
(B)
the aggregate premiums or other consideration paid for purposes of subsection (e)(6) (relating to certain amounts not received as an annuity),
any amount allowed as a deduction with respect to the contract under section
404 which was paid while the employee was an employee within the meaning of section
401
(c)(1) shall be treated as consideration contributed by the employer, and there shall not be taken into account any portion of the premiums or other consideration for the contract paid while the employee was an owner-employee which is properly allocable (as determined under regulations prescribed by the Secretary) to the cost of life, accident, health, or other insurance.
(3)
Life insurance contracts
(B)
Any contribution to a plan described in subparagraph (A)(i) or a trust described in subparagraph (A)(ii) which is allowed as a deduction under section
404, and any income of a trust described in subparagraph (A)(ii), which is determined in accordance with regulations prescribed by the Secretary to have been applied to purchase the life insurance protection under a contract described in subparagraph (A), is includible in the gross income of the participant for the taxable year when so applied.
(C)
In the case of the death of an individual insured under a contract described in subparagraph (A), an amount equal to the cash surrender value of the contract immediately before the death of the insured shall be treated as a payment under such plan or a distribution by such trust, and the excess of the amount payable by reason of the death of the insured over such cash surrender value shall not be includible in gross income under this section and shall be treated as provided in section
101.
(5)
Penalties applicable to certain amounts received by 5-percent owners
(A)
This paragraph applies to amounts which are received from a qualified trust described in section
401
(a) or under a plan described in section
403
(a) at any time by an individual who is, or has been, a 5-percent owner, or by a successor of such an individual, but only to the extent such amounts are determined, under regulations prescribed by the Secretary, to exceed the benefits provided for such individual under the plan formula.
(B)
If a person receives an amount to which this paragraph applies, his tax under this chapter for the taxable year in which such amount is received shall be increased by an amount equal to 10 percent of the portion of the amount so received which is includible in his gross income for such taxable year.
(6)
Owner-employee defined
For purposes of this subsection, the term “owner-employee” has the meaning assigned to it by section
401
(c)(3) and includes an individual for whose benefit an individual retirement account or annuity described in section
408
(a) or (b) is maintained. For purposes of the preceding sentence, the term “owner-employee” shall include an employee within the meaning of section
401
(c)(1).
(7)
Meaning of disabled
For purposes of this section, an individual shall be considered to be disabled if he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration. An individual shall not be considered to be disabled unless he furnishes proof of the existence thereof in such form and manner as the Secretary may require.
(10)
Determination of investment in the contract in the case of qualified domestic relations orders
Under regulations prescribed by the Secretary, in the case of a distribution or payment made to an alternate payee who is the spouse or former spouse of the participant pursuant to a qualified domestic relations order (as defined in section
414
(p)), the investment in the contract as of the date prescribed in such regulations shall be allocated on a pro rata basis between the present value of such distribution or payment and the present value of all other benefits payable with respect to the participant to which such order relates.
(n)
Annuities under retired serviceman’s family protection plan or survivor benefit plan
Subsection (b) shall not apply in the case of amounts received after December 31, 1965, as an annuity under chapter
73 of title
10 of the United States Code, but all such amounts shall be excluded from gross income until there has been so excluded (under section
122
(b)(1) or this section, including amounts excluded before January 1, 1966) an amount equal to the consideration for the contract (as defined by section
122
(b)(2)), plus any amount treated pursuant to section
101
(b)(2)(D) (as in effect on the day before the date of the enactment of the Small Business Job Protection Act of 1996) as additional consideration paid by the employee. Thereafter all amounts so received shall be included in gross income.
(o)
Special rules for distributions from qualified plans to which employee made deductible contributions
(3)
Amounts constructively received
(4)
Special rule for treatment of rollover amounts
For purposes of sections
402
(c),
403
(a)(4), and
403
(b)(8),
408
(d)(3), and
457
(e)(16), the Secretary shall prescribe regulations providing for such allocations of amounts attributable to accumulated deductible employee contributions, and for such other rules, as may be necessary to insure that such accumulated deductible employee contributions do not become eligible for additional tax benefits (or freed from limitations) through the use of rollovers.
(5)
Definitions and special rules
For purposes of this subsection—
(A)
Deductible employee contributions
The term “deductible employee contributions” means any qualified voluntary employee contribution (as defined in section
219
(e)(2)) made after December 31, 1981, in a taxable year beginning after such date and made for a taxable year beginning before January 1, 1987, and allowable as a deduction under section
219
(a) for such taxable year.
(B)
Accumulated deductible employee contributions
The term “accumulated deductible employee contributions” means the deductible employee contributions—
(p)
Loans treated as distributions
For purposes of this section—
(1)
Treatment as distributions