In 2017 Todd purchased an annuity for $150,000. The annuity is to pay him $2,500 per month for the rest of his life. His life expectancy is 100 months. Which of the following is correct?
A)Todd is not required to recognize any income until he has collected 60 payments (60 × $2,500 = $150,000).
B)If Todd collects 20 payments and then dies in 2018, Todd's estate should amend his tax returns for 2017 and 2018 and eliminate all of the reported income from the annuity for those years.
C)For each $2,500 payment received in the first year, Todd must include $1,000 in gross income.
D)For each $2,500 payment received in the first year, Todd must include $1,500 in gross income.
E)None of these.

Question

Quizplus · Accepted Answer

Todd purchased the annuity for $150,000 and is receiving $2,500 per month, which equals $30,000 per year. To determine the taxable portion of each payment, we need to use the exclusion ratio. The exclusion ratio is calculated by dividing the investment in the annuity by the expected return. In this case, the investment is $150,000 and the expected return (based on Todd's life expectancy) is $300,000. Therefore, the exclusion ratio is 0.5 (150,000/300,000). To determine the taxable portion of each payment, we multiply the payment by the exclusion ratio. So for each $2,500 payment, Todd must include $1,250 in gross income ($2,500 x 0.5). Over the course of a year, Todd will receive 12 payments for a total of $30,000, of which $15,000 will be taxable ($1,250 x 12).

In 2017 Todd Purchased an Annuity for $150,000