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Taxes on inherited annuity
payments
Dear Tax Talk:
My father-in-law recently died. The estate falls well below the
threshold for federal estate tax. My mother-in-law is the beneficiary
of an annuity that he had purchased in May 1997 using cash value
of a life insurance policy. He had been receiving monthly payments
of $303 since that time, which would have continued for the remainder
of his life: 40 payments were certain; 39.4 percent of the payments
were excludable from federal income tax.
The annuity was in his name only and has a payout
value of $21,619 if my mother-in-law takes the death benefit in
a lump sum. If she takes that lump sum, is it taxable income? How
do I calculate the amount that would be taxable?
She could continue to receive the $303 per month until
December 2008, but she would need to continue to pay tax on 60 percent
of those payments. This doesn't seem like a good option. If she
does take the lump sum, is there any way to roll the taxable portion
over to avoid the federal income tax?
Thank you.
David
Dear David:
I'm not sure that your father-in-law was properly advised when he
used the cash value of a life insurance policy to purchase another
insurance product.
If he wanted access to the cash value of the policy,
he should have been advised to begin taking policy loans, which
would have been tax-free. The loans would have been deducted from
the death benefit of the policy, which would also have been tax-free.
Unfortunately, you can't go back and undo what has
already occurred, but others should be cautioned by this tale.
Taxation of annuities is a complex area. The amount
to be taxed, either in future periodic payments or in settlement
in lump sum, depends on the unrecovered investment in the contract.
It also depends on interest rates that have changed and certain
other insurance-related features that will vary the results. So,
unfortunately, I can't give you a definite answer, but can guide
you on questions you need to ask the insurer.
The unrecovered investment is the original amount
paid for the contract less the amount already recovered tax-free
(i.e., the 39.4 percent of each $303 payment from the annuity start
until his death).
For purposes of further illustration, I'll assume
your father-in-law received 50 payments prior to his death and he
paid $25,000 for the annuity contract. Therefore, your father-in-law
recovered tax-free $5,969 (39.4 percent of $303 multiplied by 50
payments) of his $25,000 investment tax-free and has an unrecovered
investment of $19,031 either to be recovered tax-free from the lump
sum or from the 90 future payments ($211.45 per payment).
As you can see, the entire lump-sum settlement will
not be taxable, but to determine how much will be taxable you'll
need to discuss the issue with the insurer.
I do not believe that the policy can be rolled over
tax-free since payments have commenced.
Basis of an inherited house
Dear Tax Talk:
I was left one-third share of my mother's house when she died. I
plan on selling my portion to my daughter, who is living there already,
for $135,000. The house is assessed for $375,000. What is my tax
obligation?
Maria
Dear Maria:
Since you inherited the property from your mother at her death,
the cost you use for purposes of determining gain is the value at
the time of her death. Assuming this is the value that you'll use
for the sale to your daughter, you'll have no gain to report for
tax purposes from the sale.
-- Posted: Aug. 17, 2001
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