Question

Jerry receives an annuity payment of $2,500 per month. Jerry purchased the 20-yer annuity for $250,000. What is the amount of the annuity that represents a return of capital and is, therefore, nontaxable?

a. 41.67% or $12,500 per year
b. 100% or $30,000 per year
c. 10% or $3,000 per year
d. 12% or $3,600 per year

Answer 1

Jerry's annuity payment that represents a return of capital is 41.67% of each payment. Since the annual payment is $30,000, the nontaxable amount per year is $12,500.

Step-by-step explanation:

The question asks us to determine the portion of Jerry's annuity payment which represents a return of capital and is therefore non-taxable. To calculate this, we need to divide the original investment by the total return over the life of the annuity. Jerry purchased the annuity for $250,000, and since he receives $2,500 per month for 20 years, the total payout will be $2,500 × 12 months × 20 years = $600,000.

The portion of each payment that is a return on the original investment is found by dividing the original investment by the total amount received from the annuity. That gives us $250,000 ÷ $600,000, which simplifies to $250/$600 or approximately 41.67% of each payment. So, in one year, Jerry receives $2,500 × 12 = $30,000, and the nontaxable portion is 41.67% of that or $12,500.