Question

Jarvis, a single taxpayer, retired from his job as a public school teacher in 2019. He is to receive a retirement annuity of $1,000 each month and his life expectancy is 150 months. He contributed $30,000 to the pension plan during his 35-year career, so his adjusted basis is $30,000. Which of the following is the correct method for reporting the pension income?

a.The first $30,000 received is a nontaxable recovery of capital, and all subsequent annuity payments are taxable.
b.The first $120,000 he receives is taxable, and the last $30,000 is a nontaxable recovery of capital.
c.For the first 150 months, 80% of the amount received is a nontaxable recovery of capital that must be included in gross income.
d.Since Jarvis is no longer working, none of the pension must be included in his gross income.
e.For the first 150 months, 20% ($30,000/$150,000) of the amount received is a nontaxable recovery of capital and the balance is included in gross income.

Answer 1

For Jarvis' retirement annuity, 20% of each monthly payment is a nontaxable recovery of capital and the remaining 80% is taxable income, based on his $30,000 contribution and total expected return of $150,000 over 150 months.

Step-by-step explanation:

For Jarvis, a single taxpayer who retired from his job as a public school teacher and receives a retirement annuity, the correct method for reporting pension income follows the guidelines of the IRS for annuity payments after retirement. Given that Jarvis has an adjusted basis of $30,000 in his pension plan from prior contributions, and he is expected to receive $1,000 per month for 150 months, he should report part of each payment as a nontaxable recovery of capital and the rest as income.

The correct way to determine the nontaxable portion and the taxable income of the annuity payment is by using the exclusion ratio. The formula for this is the total contribution to the plan (adjusted basis) divided by the total expected return. In Jarvis' case, this ratio is $30,000 (his contribution) divided by $150,000 (the total amount he is expected to receive over 150 months), which is 20%. Therefore, each month, 20% of his annuity ($200) is considered a nontaxable recovery of his contribution, and the remaining 80% ($800) is taxable income.

Thus, the correct answer to how Jarvis should report his pension income is that for the first 150 months, 20% of the amount received is a nontaxable recovery of capital and the balance is included in gross income.