Larry purchased an annuity from an insurance company that promises to pay him $11,500 per month for the rest of his life. Larry paid $1,410,360 for the annuity. Larry is in good health and is 72 years old. Larry received the first annuity payment of $11,500 this month. Use the expected number of payments in Exhibit 5-1 for this problem. b. If Larry lives more than 15 years after purchasing the annuity, how much of each additional payment should he include in gross income

If Larry outlives the IRS's life expectancy, he has two options:

Explanation:

According to the IRS, Larry's life expectancy is 15.5 more years (IRS publication 590, appendix b , table I: single life expectancy), so the total number of distributions = 15.5 x 12 = 186.

for tax purposes, he can deduct $1,410,360 / 186 = $7,582.58 from each distribution. This means that he will only have to pay income taxes for $11,500 - $7,582.58 = $3,917.42.

If Larry outlives the IRS's life expectancy, he has two options:

He must pay taxes for the full amount that he receives every month beginning with the 187th payment. The IRS allows you to deduct the cost of the annuity, but if you already discounted the full cost, then you start paying taxes for every cent that you get.

Or he can recalculate his tax deduction. But recalculating when you are about to pass the age threshold doesn't make sense. After he turns 87, Larry will only be able to deduct $45,495.48 more. It sounds like a lot of money, but since the IRS doesn't recognize any interest on your investment, then the sooner you discount your taxes, the better.

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