section 1 - The American College Online Learning Center

e. Annuitization(1) The tax treatment is different if a contract is annuitized, now a portionof each payment (based on the exclusion ratio) is treated as a return ofprincipal and the remaining distribution is treated as taxable income.(2) The exclusion ratio is the cost basis (premiums reduced by any return ofcontributions) divided by the expected return (based on the type of annuity).(3) This fraction (exclusion ratio) is multiplied by the amount of the distributionto determine the portion of each distribution that is excluded from income.(4) Once the cost basis has been recovered all future payments are taxable.(5) Calculating the exclusion ratio depends on the following factors(a) Single or joint life annuity(b) Refund feature(c) Inflation rider(6) Death of participant(a) If payments cease at death, remaining cost basis is deducted in theyear of death(b) If payments continue to a beneficiary, continue recovering costbasis using the exclusion ratio.(7) Variable annuities(a) Calculate exclusion ratio by simply dividing cost basis by the lifeexpectancy.(b) If the variable annuity performs badly, the excludable amount mayexceed actual payments in which case the remaining amount notexcluded is prorated over the remaining life expectancy (payment of$10,000 and basis of $12,000 means $2,000 that can be recoveredover the remaining life expectancy).LO 4-1-6: Identify how Social Security benefits are taxed1. A portion of Social Security benefits are included in taxable income if a client’s provisionalincome exceeds thresholds provided in Code Sec. 86. In order to determine the taxableamount of Social Security, we must first calculate a client’s provisional income. (Video:How are Social Security benefits taxed? Littell, Tacchino)2. Provisional income is equal to AGI plus ½ of the Social Security income, plus othernontaxable interest (such as interest on tax-exempt bonds).3. Example: Virginia has an AGI of $50,000, plus $10,000 in municipal bond income, plusSocial Security income of $20,000. Her provisional income is $70,000. ($50,000 AGI +$10,000 bond income + ½ x $20,000 in Social Security ($10,000)).4. A single person with $25,000 or less in provisional income will pay no taxes on his or herSocial Security income.5. A married couple who files jointly with $32,000 or less in provisional income will payno taxes on their Social Security income.6. A single person whose provisional income is $25,000 to $34,000 may have up to 50percent of his or her Social Security income taxed.4.20