[Code of Federal Regulations]
[Title 26, Volume 2]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.72-7]
[Page 168-175]
TITLE 26--INTERNAL REVENUE
CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY
(CONTINUED)
PART 1_INCOME TAXES--Table of Contents
Sec. 1.72-7 Adjustment in investment where a contract contains a refund
feature.
(a) Definition of a contract containing a refund feature. A contract
to which section 72 applies, contains a refund feature if:
(1) The total amount receivable as an annuity under such contract
depends, in whole or in part, on the continuing life of one or more
persons,
(2) The contract provides for payments to be made to a beneficiary
or the estate of an annuitant on or after the death of the annuitant if
a specified amount or a stated number of payments has not been paid to
the annuitant or annuitants prior to death, and
(3) Such payments are in the nature of a refund of the consideration
paid. See paragraph (c)(1) of Sec. 1.72-11.
(b) Adjustment of investment for the refund feature in the case of a
single life annuity. Where a single life annuity contract to which
section 72 applies contains a refund feature and the special rule of
paragraph (d) of this section does not apply, the investment in the
contract shall be adjusted in the following manner:
(1) Determine the number of years necessary for the guaranteed
amount to be fully paid by dividing the maximum amount guaranteed as of
the annuity starting date by the amount to be received annually under
the contract to the extent such amount reduces the guaranteed amount.
The number of years should be stated in terms of the nearest whole year,
considering for this purpose a fraction of one-half or more as an
additional whole year.
(2) Consult Table III or VII (whichever is applicable) of Sec.
1.72-9 for the appropriate percentage under the whole number of years
found in subparagraph (1) of this paragraph and the age (as of the
annuity starting date) and, if applicable, sex of the annuitant.
(3) Multiply the percentage found in subparagraph (2) of this
paragraph by whichever of the following is the smaller: (i) The
investment in the contract found in accordance with Sec. 1.72-6 or (ii)
the total amount guaranteed as of the annuity starting date.
(4) Subtract the amount found in subparagraph (3) of this paragraph
from the investment in the contract found in accordance with Sec. 1.72-
6.
The resulting amount is the investment in the contract adjusted for the
present value of the refund feature without discount for interest and is
to be used in determining the exclusion ratio to be applied to the
payments received as an annuity. The percentage found in Tables III or
VII shall not be adjusted in a manner described in paragraph (a)(2) of
Sec. 1.72-5. These principles may be illustrated by the following
examples:
Example (1). On January 1, 1954, a husband, age 65, purchased for
$21,053, an immediate installment refund annuity payable $100 per month
for life. The contract provided that in the event the husband did not
live long enough to recover the full purchase price, payments were to be
made to his wife until the total payments under the contract equaled the
purchase price. The investment in the contract adjusted for the purpose
of determining the exclusion ratio is computed in the following manner:
Cost of the annuity contract (investment in the contract, $21,053
unadjusted)...............................................
Amount to be received annually............................. $1,200
Number of years for which payment guaranteed ($21,053 17.5
divided by $1,200)........................................
Rounded to nearest whole number of years................... 18
[[Page 169]]
Percentage located in Table III for age 65 (age of the 30
annuitant as of the annuity starting date) and 18 (the
number of whole years) (percent)..........................
Subtract value of the refund feature to the nearest dollar $6,316
(30 percent of $21,053)...................................
------------
Investment in the contract adjusted for the present value $14,737
of the refund feature without discount for interest.......
Example (2). Assume the same facts as in example (1), except that
the total investment in the contract was made after June 30, 1986. The
investment in the contract adjusted for the purpose of determining the
exclusion ratio is computed as follows:
Cost of the annuity contract (investment in the contract, $21,053
unadjusted)...............................................
Amount to be received annually............................. $1,200
Number of years for which payment guaranteed ($21,053/ 17.5
$1,200)...................................................
Rounded to nearest whole number of years................... 18
Percentage in Table VII for age 65 and 18 years (percent).. 15
Subtract value of the refund feature to the nearest dollar $3,158
(15 percent of $21,053)...................................
------------
Investment in the contract adjusted for the present value $17,895
of the refund feature without discount for interest.......
Example (3). Assume the same facts as in example (1), except that
the pre-July 1986 investment in the contract is $10,000 and the post-
June 1986 investment in the contract is $11,053. If the annuitant makes
the election described in Sec. 1.72-6(d)(6), separate computations must
be performed pursuant to Sec. 1.72-6(d) to determine the adjusted
investment in the contract. The pre-July 1986 investment in the contract
and the post-June 1986 investment in the contract adjusted for the
purpose of determining the exclusion ratios are, respectively, $7,000
and $9,395, determined as follows:
Pre-July 1986 investment in the contract (unadjusted)...... $10,000
Pre-July 1986 portion of the amount to be received annually $570.00
($10,000/$21,053x$1,200)..................................
Number of years for which payment guaranteed ($10,000/ 17.50
$570).................................................
Rounded to nearest whole number of years............... 18
Percentage in Table III for age 65 and 18 years 30
(percent).............................................
Subtract value of the refund feature to the nearest $3,000
dollar (30 percent of $10,000)........................
Pre-July 1986 investment in the contract adjusted for the $7,000
present value of the refund feature without discount for
interest..................................................
============
Post-June 1986 investment in the contract (unadjusted)..... $11,053
Post-June 1986 portion of the amount to be received $630
annually ($11,053/$21,053x$1,200).........................
Number of years for which payment guaranteed ($11,053/$630) 17.54
Rounded to nearest whole number of years................... 18
Percentage in Table VII for age 65 and 18 years (percent).. 15
Subtract value of the refund feature to the nearest dollar $1,658
(15 percent of $11,053)...................................
------------
Post-June 1986 investment in the contract adjusted for the $9,395
present value of the refund feature without discount for
interest..................................................
If, in the above examples, the guaranteed amount had exceeded the
investment in the contract (or applicable portion thereof), the
percentage found in Table III or VII (whichever is applicable) should
have been applied to the lesser of these amounts since any excess of the
guaranteed amount over the investment in the contract (as found under
Sec. 1.72-6) would not have constituted a refund of premiums or other
consideration paid. In such a case, however, a different multiple might
have been obtained from Table III or VII (whichever is applicable) since
the number of years for which payments were guaranteed would have been
greater.
(c) Adjustment of investment for the refund feature in the case of a
joint and survivor annuity. (1) Except as provided in paragraph (c)(2)
of this section, if a joint and survivor annuity contract described in
paragraph (b) (1), (2) or (6) of Sec. 1.72-5 contains a refund feature
and the special rule of paragraph (d) of this section does not apply,
the investment in the contract shall be adjusted in the following
manner:
(i) Find the percentage determined under the following formula:
[[Page 170]]
[GRAPHIC] [TIFF OMITTED] TC05OC91.042
In which:
V = The percentage, rounded to the nearest whole percent,
x = The age at the nearest birthday of the primary annuitant,
y = The age at the nearest birthday of the survivor annuitant,
N = The guaranteed amount divided by the annual annuity payable to the
primary annuitant, rounded to the nearest integer,
P = The annual annuity continued to the survivor annuitant divided by
the annual annuity payable to the primary annuitant,
[GRAPHIC] [TIFF OMITTED] TC05OC91.043
(ii) Multiply the percentage found in paragraph (c)(1)(i) of this
section by the lesser of (A) the investment in the contract found in
accordance with Sec. 1.72-6, or (B) the total amount guaranteed as of
the annuity starting date.
(iii) Subtract the amount found in paragraph (c)(1)(ii) of this
section from the investment in the contract found in accordance with
Sec. 1.72-6.
In the case of a contract providing for payments to be made to two
persons in the manner described in paragraph (b)(6) of Sec. 1.72-5,
this paragraph (c)(1) is applied as though the older person were the
primary annuitant and the younger person were the survivor annuitant.
For purposes of this paragraph (c)(1), the number of survivors at
agex (lx) is determined under the following table:
------------------------------------------------------------------------
x lx
------------------------------------------------------------------------
5.................................................... 1000000.
6.................................................... 999729.
7.................................................... 999493.
8.................................................... 999284.
9.................................................... 999069.
10................................................... 998849.
11................................................... 998620.
12................................................... 998382.
13................................................... 998135.
14................................................... 997876.
15................................................... 997606.
16................................................... 997322.
17................................................... 997025.
18................................................... 996714.
19................................................... 996387.
20................................................... 996044.
21................................................... 995684.
22................................................... 995304.
23................................................... 994905.
24................................................... 994484.
25................................................... 994041.
26................................................... 993573.
27................................................... 993080.
28................................................... 992563.
29................................................... 992024.
30................................................... 991461.
31................................................... 990876.
32................................................... 990269.
33................................................... 989638.
34................................................... 988984.
35................................................... 988303.
36................................................... 987593.
37................................................... 986846.
38................................................... 986055.
39................................................... 985210.
40................................................... 984298.
41................................................... 983310.
42................................................... 982230.
43................................................... 981046.
[[Page 171]]
44................................................... 979742.
45................................................... 978302.
46................................................... 976709.
47................................................... 974945.
48................................................... 972992.
49................................................... 970832.
50................................................... 968447.
51................................................... 966000.
52................................................... 963313.
53................................................... 960375.
54................................................... 957175.
55................................................... 953705.
56................................................... 949954.
57................................................... 945912.
58................................................... 941568.
59................................................... 936908.
60................................................... 931903.
61................................................... 926451.
62................................................... 920540.
63................................................... 914090.
64................................................... 907011.
65................................................... 899221.
66................................................... 890428.
67................................................... 880797.
68................................................... 870298.
69................................................... 858904.
70................................................... 846565.
71................................................... 832316.
72................................................... 816861.
73................................................... 800078.
74................................................... 781837.
75................................................... 762012.
76................................................... 740743.
77................................................... 717689.
78................................................... 692780.
79................................................... 665977.
80................................................... 637260.
81................................................... 607339.
82................................................... 575531.
83................................................... 541919.
84................................................... 506647.
85................................................... 469931.
86................................................... 432459.
87................................................... 394138.
88................................................... 355393.
89................................................... 316712.
90................................................... 278663.
91................................................... 242020.
92................................................... 207150.
93................................................... 174602.
94................................................... 144828.
95................................................... 118151.
96................................................... 94871.7
97................................................... 74863.6
98................................................... 58042.2
99................................................... 44176.1
100.................................................. 32956.4
101.................................................. 24044.8
102.................................................. 17104.1
103.................................................. 11815.5
104.................................................. 7886.75
105.................................................. 5054.94
106.................................................. 3086.95
107.................................................. 1778.82
108.................................................. 955.465
109.................................................. 470.955
110.................................................. 208.668
111.................................................. 80.7899
112.................................................. 26.2340
113.................................................. 6.69620
114.................................................. 1.19385
115.................................................. .111460
------------------------------------------------------------------------
(2) If the multiples in Tables I through IV of Sec. 1.72-9 are used
to determine any portion of the expected return under a contract
described in paragraph (c)(1) of this section, only the post-June 1986
investment in the contract (if any) shall be adjusted in the manner
described in paragraph (c)(1) of this section, and the pre-July 1986
investment in the contract shall, in the case of a contract described in
paragraph (b) (1) or (6) of Sec. 1.72-5, be adjusted in the following
manner:
(i) Determine the number of years necessary for the guaranteed
amount to be fully paid by dividing the maximum amount guaranteed as of
the annuity starting date by the amount to be received annually under
the contract. The number of years should be stated in terms of the
nearest whole year, considering for this purpose a fraction of one-half
or more as an additional whole year.
(ii) Consult Table III of Sec. 1.72-9 for the appropriate
percentages under the whole number of years found in subdivision (i) of
this subparagraph and the age (as of the annuity starting date) and sex
of each annuitant. If the annuitants are not of the same sex, substitute
for the female annuitant a male annuitant 5 years younger, or for the
male annuitant a female annuitant 5 years older, so that Table III will
be entered in both cases with the ages of annuitants of the same sex.
(iii) Find the sum of the two percentages found in accordance with
subdivision (ii) of this subparagraph.
(iv) To the age of the elder of the two annuitants (as determined
under subdivision (ii) of this subparagraph), add the number of years
(indicated in the table below) opposite the number of years by which
such annuitants' ages differ:
------------------------------------------------------------------------
Addition to
Number of years difference in age (2 male annuitants or 2 older age
female annuitants) in years
------------------------------------------------------------------------
0 to 1, inclusive.......................................... 9
2 to 3, inclusive.......................................... 8
4 to 5, inclusive.......................................... 7
6 to 8, inclusive.......................................... 6
9 to 11, inclusive......................................... 5
12 to 15, inclusive........................................ 4
16 to 20, inclusive........................................ 3
21 to 27, inclusive........................................ 2
28 to 42, inclusive........................................ 1
Over 42.................................................... 0
------------------------------------------------------------------------
[[Page 172]]
(v) Consult Table III for the appropriate percentage under the whole
number of years found in subdivision (i) of this subparagraph and the
age and sex of the elder annuitant as adjusted under subdivision (iv) of
this subparagraph.
(vi) Subtract the percentage obtained in subdivision (v) of this
subparagraph from the sum of the percentages found under subdivision
(iii) of this subparagraph. If the result is less than one, subdivisions
(vii) and (viii) of this subparagraph shall be disregarded and no
adjustment made to the investment in the contract.
(vii) Multiply the percentage found in subdivision (vi) of this
subparagraph by whichever of the following is the smaller: (A) the
investment in the contract found in accordance with Sec. 1.72-6 or (B)
the total amount guaranteed as of the annuity starting date.
(viii) Subtract the amount found in subdivision (vii) of this
subparagraph from the investment in the contract found in accordance
with Sec. 1.72-6.
(3) The principles of this paragraph (c) may be illustrated by the
following examples:
Example (1). Prior to July 1, 1986, Taxpayer A, a 70-year-old male,
purchases a joint and last survivor annuity for $33,050. The contract
provides for payments of $100 a month to be paid first to himself for
life and then to B, his 40-year-old daughter, if she survives him. The
contract further provides that in the event both die before ten years'
payments have been made, payments will be continued to C, a beneficiary,
or to C's estate, until ten years' payments have been made. If there is
no post-June 1986 investment in the contract, the investment in the
contract adjusted for the purpose of determining the exclusion ratio is
computed in the following manner:
Cost of the annuity contract (investment in the contract $33,050
unadjusted)...............................................
Guaranteed amount ($1,200x10).............................. $12,000
============
Percentage in Table III for male, age 70 (or female, age 21
75) for duration of the guarantee (10)....................
Percentage in Table III for female, age 40 (or male, age 2
35) for duration of the guarantee (10)....................
------------
Sum of percentages obtained............................ 23
============
Difference in years of age between two males, aged 70 and 35
35 (or 2 females, aged 75 and 40).........................
Addition, in years, to older age........................... 1
Percentage in Table III for male one year older than A..... 22
Difference between percentages obtained (23 percent less 22 1
percent)..................................................
Value of the refund feature to the nearest dollar (1 $120
percent of $12,000).......................................
------------
Investment in the contract adjusted for present value $32,930
of the refund feature.................................
Example (2). The facts are the same as in example (1), except that
the total investment in the contract was made after June 30, 1986, A is
73 years of age, and B is A's 70 year old spouse. The percentage
determined under the formula in paragraph (c)(1)(i) of this section is
two percent. Thus, the amount determined under paragraph (c)(1)(ii) of
this section is $240 (2 percent of $12,000), and the investment in the
contract adjusted for the present value of the refund feature is $32,810
($33,050--$240).
(4) If an annuity described in paragraph (b) of Sec. 1.72-5
contains a refund feature and the manner of determining the adjustment
to the investment in the contract (or to any part of such investment) is
not prescribed or requires use of the formula in paragraph (c)(1)(i) of
this section, the Commissioner will determine the amount of the
adjustment upon request. The request must contain the date of birth of
each annuitant, the guaranteed amount, the annual annuity payable to
each annuitant, and the annuity starting date. Send the request to the
Commissioner of Internal Revenue, Attention: OP:E:EP:GA, Washington,
D.C. 20224.
(d) Adjustment of investment in the contract where paragraph (b)(3)
of Sec. 1.72-2 applies to payments. (1) If paragraph (b)(3) of Sec.
1.72-2 applies to payments to be made under a contract and this section
also applies because of the provision for a refund feature, an
adjustment shall be made to the investment in the contract in accordance
with this paragraph before making the computations required by paragraph
(d)(3) of Sec. 1.72-4 and paragraph (d)(7) of Sec. 1.72-5. In the case
of the guarantee of a specified amount, the adjustment shall be made by
applying the appropriate multiple from Table III or VII (whichever
[[Page 173]]
is applicable), as otherwise determined under this section, to the
investment in the contract or the guranteed amount, whichever is the
lesser. The guarantee period shall be found by dividing the amount
guaranteed by the amount determined by placing the payments received
during the first taxable year (to guaranteed amount) on an annual basis.
Thus, if monthly payments are first received by a taxpayer on a calendar
year basis in August, his total payments (to the extent that they reduce
the guaranteed amount) for the taxable year would be divided by 5 and
multiplied by 12. The guaranteed amount would then be divided by the
result of this computation to obtain the guarantee period. If the
contract merely guarantees that proceeds from a unit or units of a fund
shall be paid for a fixed number of years or the life (or lives) of an
annuitant (or annuitants), whichever is the longer, the fixed number of
years is the guarantee period. The appropriate percentage in Table III
or VII shall be applied to whichever of the following is the smaller:
(i) the investment in the contract; or (ii) the product of the payments
received in the first taxable year, placed on an annual basis,
multiplied by the number of years for which payment of the proceeds of a
unit or units is guaranteed.
(2) The principles of this paragraph may be illustrated by the
following examples:
Example (1). Taxpayer A, a 50-year-old male purchases for $25,000 a
contract which provides for variable monthly payments to be paid to him
for his life. The contract also provides that if he should die before
receiving payments for fifteen years, payments shall continue according
to the original formula to his estate or beneficiary until payments have
been made for that period. Beginning with the month of September, A
receives payments which total $450 for the first taxable year of
receipt. This amount, placed on an annual basis, is $1,350 ($450 divided
by 4, or $112.50; $112.50 multiplied by 12, or $1,350). If there is no
post-June 1986 investment in the contract, the guaranteed amount is
considered to be $20,250 ($1,350x15), and the multiple from Table III
(found in the same manner as in paragraph (b) of this section), 9
percent, applied to $20,250 (since this amount is less than the
investment in the contract), results in a refund adjustment of
$1,822,50. The latter amount, subtracted from the investment in the
contract of $25,000, results in an adjusted investment in the contract
of $23,177.50. If A dies before receiving payments for 15 years and the
remaining payments are made to B, his beneficiary, B shall exclude the
entire amount of such payments from his gross income until the amounts
so received by B, together with the amount received by A and excludable
from A's gross income, equal or exceed $25,000. Any excess and any
payments thereafter received by B shall be fully includible in gross
income.
Example (2). Assume the same facts as in example (1), except that
the total investment in the contract was made after June 30, 1986. The
applicable multiple found in Table VII is 3 percent. When this is
applied to the guaranteed amount of $20,250, it results in a refund
adjustment of $607.50. The adjusted investment in the contract in
$24,392.50 ($25,000--$607.50).
(e) Adjustment of the investment in the contract where more than one
annuity element is provided for a single consideration. In the case of
contracts to which paragraph (b) of Sec. 1.72-6 applies for the purpose
of allocating the investment in the contract to two or more annuity
elements which are provided for a single consideration, if one or more
of such elements involves a refund feature, the portion of the
investment in the contract properly allocable to each such element shall
be adjusted for the refund feature before aggregating all the
investments in order to obtain the exclusion ratio which is to apply to
the contract as a whole.
Example (1). If taxpayer A, an insured 70 years of age, upon
maturity of an endowment policy which cost him a net amount of $86,000,
elected a dual settlement consisting of (1) monthly payments for his
life aggregating $4,146 per year with 10 years' payments certain, and
(2) monthly payments for his 60-year-old brother, B, aggregating $2,820
per year with 20 years' payments certain, the exclusion ratio to be used
by both A and B if there is no post-June 1986 investment in the contract
would be determined in the following manner:
A's expected return (A's payments per year of $4,146 $50,166.60
multiplied by his life expectancy from Table 1 of
12.1)...............................................
B's expected return (B's payments per year of $2,820 $51,324.00
multiplied by his life expectancy from Table 1 of
18.2)...............................................
------------------
[[Page 174]]
Sum of expected returns to be used in determining $101,490.60
exclusion ratio.................................
==================
Percentage of total expected return attributable to 49.4
A's expectancy of life ($50,166.60/$101,490.60).....
Percentage of total expected return attributable to 50.6
B's expectancy of life ($51,324/$101,490.60)........
Portion of investment in the contract allocable to $42,484.00
A's annuity (49.4 percent of $86,000)...............
Portion of investment in the contract allocable to $43,516.00
B's annuity (50.6 percent of $86,000)...............
Value of the refund feature with respect to A's $8,707.00
annuity (percentage from Table III for male, age 70,
and duration 10, or 21 percent, multiplied by lesser
of guaranteed amount and allocable portion of
investment in the contract, $41,460)................
A's allocable portion of the investment in the $33,777.00
contract adjusted for refund feature ($42,484 less
$8,707.00)..........................................
Value of the refund feature with respect to B's $10,879.00
annuity (percentage from Table III for male, age 60,
and duration 20, or 25 percent, multiplied by lesser
of guaranteed amount and allocable portion of
investment in the contract, $43,516)................
B's allocable portion of the investment in the $32,637.00
contract adjusted for refund feature ($43,516 less
$10,879.00).........................................
Sum of A's and B's allocable portions of the $66,414.00
investment in the contract after adjustment for the
refund feature......................................
Exclusion ratio for the contract as a whole (total 65.4
adjusted investment in the contract, $66,414,
divided by the total expected return from above,
$101,490.60) (percent)..............................
Example (2). Assume the same facts as in example (1) except that the
total investment in the contract was made after June 30, 1986. The
exclusion ratio to be used by both A and B would be 56.9 percent,
determined as follows:
A's expected return (A's payments per year of $4,146 $66,336.00
multiplied by his life expectancy from Table V of
16.0)...............................................
B's expected return (B's payments per year of $2,820 $68,244.00
multiplied by his life expectancy from Table V of
24.2)...............................................
------------------
Sum of expected returns to be used in determining $134,580.00
exclusion ratio.....................................
==================
Percentage of total expected return attributable to 49.3
A's expectancy of life ($66,336.00/$134,580.00).....
Percentage of total expected return attributable to 50.7
B's expectancy of life ($68,244.00/$134,580.00).....
Portion of investment in the contract allocable to $42,398.00
A's annuity (49.3 percent of $86,000)...............
Portion of investment in the contract allocable to $43,602.00
B's annuity (50.7 percent of $86,000)...............
Value of the refund feature with respect to A's $4,560.60
annuity (percentage from Table VII for age 70 and
duration 10, or 11 percent, multiplied by lesser of
the guaranteed amount and allocable portion of
investment in the contract, $41,460)................
A's allocable portion of the investment in the $37,837.40
contract adjusted for refund feature ($42,398 less
$4,560.60)..........................................
Value of the refund feature with respect to B's $4,796.22
annuity (percentage from Table VII for age 60 and
duration 20, or 11 percent, multiplied by lesser of
guaranteed amount and allocable portion of
investment in the contract, $43,602)................
B's allocable portion of the investment in the $38,805.78
contract adjusted for refund feature ($43,602 less
$4,796.22)..........................................
------------------
Sum of A's and B's allocable portions of the $76,643.18
investment in the contract after adjustment for the
refund feature......................................
[[Page 175]]
Exclusion ratio for the contract as a whole (total 56.9
adjusted investment in the contract, $76,643.18,
divided by the total expected return from above,
$134,580.00) (percent)..............................
(f) Adjustment of investment in the contract with respect to
contracts subject to Sec. 1.72-6(d). In the case of a contract to which
Sec. 1.72-6(d) (relating to contracts in which amounts were invested
both before July 1, 1986, and after June 30, 1986) applies, this section
is applied in the manner prescribed in Sec. 1.72-6(d) and, in
particular, Sec. 1.72-6(d)(5)(vi).
[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960, as
amended by T.D. 8115, 51 FR 45702, Dec. 19, 1986]