Question

George purchased a life annuity for $6,400 that will provide him $160 monthly payments for as long as he lives. Based on IRS tables, George's life expectancy is 100 months. How much of the first $160 payment will George include in his gross income?

Answer 1

George will include $96 of the first $160 monthly annuity payment in his gross income, calculated using the exclusion ratio based on his life expectancy and the amount he paid for the life annuity.

Step-by-step explanation:

To determine how much of the first $160 payment George will include in his gross income, we start by figuring out the exclusion ratio for his life annuity. The exclusion ratio is calculated to find out which portion of the annuity payment is a return on the investment (principal) and which portion is considered gain (and thus taxable).

First, we calculate the total expected return over his life expectancy, which is the monthly payment times life expectancy:

• $160 \times 100 = $16,000

The amount George paid for the annuity is $6,400. So, to find the tax-free portion of each payment:

• $6,400 \divided by $16,000 = 0.40 or 40%

Thus, 40% of each monthly payment is not taxed. Now, multiplying this percentage by the monthly payment gives the tax-free amount:

• $160 \times 0.40 = $64

George's gross income will include the remaining amount, which is:

• $160 - $64 = $96

Therefore, George will include $96 of the first $160 payment in his gross income.