Question

Alex Cross has purchased an annuity for $70,000 and is to receive $600 per month for life. He is 65 years old and has a life expectancy of 14 years.

a. Apply the exclusion ratio formula to determine how much of his annual annuity income is TAXABLE. Your answer should be in dollars.

b. If Cross is still alive and collecting annuity payments at age 81, what percentage of his income is TAXABLE?

Answer 1

calculate your exclusion ratio by dividing your initial investment by your number of payment periods. Each month anything over the exclusion ratio amount would be considered taxable income

Initial investment = $70000

Expected no. of payments = 14 years = 14*12 months = 168months

Exclusion ratio = 70,000/168 = $416.67 per month

Taxable income per month = $600 - $416.67 = $183.33

Annual taxable income = $183.33*12 = $2200

(b) For a lifetime annuity, you calculate the exclusion ratio as in a standard, fixed-period annuity contract. At a certain point, however, you will have collected back the entire initial investment. At this point, the exclusion ratio will fall off and the entire income of the annuity will become taxable.

If you survive for more than 14 years, your entire annuity amount will be taxed.