Computation Under the General Rule: Annuity Tax Calculations (2025 IRS Guide)

This guide covers “Computation Under the General Rule” within annuity tax calculations. The following material presents the IRS treatment of this topic, including the qualifications, exceptions, and examples in the source section. Read the rules alongside the facts of your own situation before deciding what to report, deduct, or document.

Adapted from Publication 939 (12/2025), General Rule for Pensions and Annuities, published by the Internal Revenue Service. This guide retains the source edition’s years, amounts, deadlines, and examples. It is guidance for that edition, not a statement that the same figures apply to every tax year.

Context for these rules

This section explains how the periodic payments you receive under a pension or annuity plan are taxed under the General Rule. Periodic payments are amounts paid at regular intervals (such as weekly, monthly, or yearly) for a period of time greater than 1 year (such as for 15 years or for life). These payments are also known as amounts received as an annuity.

Tip: If you receive an amount from your plan that is a nonperiodic payment (amount not received as an annuity), see Taxation of Nonperiodic Payments in Pub. 575.

In general, you can recover your net cost of the pension or annuity tax free over the period you are to receive the payments. The amount of each payment that is more than the part that represents your net cost is taxable. Under the General Rule, the part of each annuity payment that represents your net cost is in the same proportion that your investment in the contract is to your expected return. These terms are explained in the following discussions.

Computation Under the General Rule

Note:

Variable annuities use a different computation for determining the exclusion amounts. See Variable annuities, later.

Under the General Rule, you figure the taxable part of your annuity by using the following steps.

Step 1.

Figure the amount of your investment in the contract, including any adjustments for the refund feature and the death benefit exclusion, if applicable. See Death benefit exclusion, earlier.

Step 2.

Figure your expected return.

Step 3.

Divide Step 1 by Step 2 and round to three decimal places. This will give you the exclusion percentage.

Step 4.

Multiply the exclusion percentage by the first regular periodic payment. The result is the tax-free part of each pension or annuity payment.

The tax-free part remains the same even if the total payment increases due to variation in the annuity amount such as cost of living increases, or you outlive the life expectancy factor used. However, if your annuity starting date is after 1986, the total amount of annuity income that is tax free over the years can’t exceed your net cost.

Each annuitant applies the same exclusion percentage to their initial payment called for in the contract.

Step 5.

Multiply the tax-free part of each payment (Step 4) by the number of payments received during the year. This will give you the tax-free part of the total payment for the year.

Tip: In the first year of your annuity, your first payment or part of your first payment may be for a fraction of the payment period. This fractional amount is multiplied by your exclusion percentage to get the tax-free part.

Step 6.

Subtract the tax-free part from the total payment you received. The rest is the taxable part of your pension or annuity.

Example 1.

You purchased an annuity with an investment in the contract of $10,800. Under its terms, the annuity will pay you $100 a month for life. The multiple for your age (age 65) is 20.0 as shown in Table V. Your expected return is $24,000 (20 × 12 × $100). Your cost of $10,800 divided by your expected return of $24,000 equals 45.0%. This is the percentage you won't have to include in income.

Each year, until your net cost is recovered, $540 (45% of $1,200) will be tax free and you will include $660 ($1,200 − $540) in your income. If you had received only six payments of $100 ($600) during the year, your exclusion would have been $270 (45% of $100 × six payments).

Example 2.

You bought a joint and survivor annuity. Your investment in the contract is $62,712 and the expected return is $121,200. The exclusion percentage is 51.7% ($62,712 ÷ $121,200). You will receive $500 a month ($6,000 a year). Each year, until your net cost is recovered, $3,102 (51.7% of your total payments received of $6,000) will be tax free and $2,898 ($6,000 − $3,102) will be included in your income. If you die, your spouse will receive $350 a month ($4,200 a year). If you don’t recover all of your net cost before your death, your spouse will use the same exclusion percentage (51.7%). Each year, until the entire net cost is recovered, your spouse will receive $2,171.40 (51.7% of your spouse’s payments received of $4,200) tax free. Your spouse will include $2,028.60 ($4,200 − $2,171.40) on the income tax return.

Example 3.

Using the same facts as Example 2, earlier under Different payments to survivor, you are to receive an annual annuity of $4,800 until you die or remarry. Your two children each receive annual annuities of $1,800 until they reach age 18. Your spouse contributed $25,576 to the plan. You are eligible for the $5,000 death benefit exclusion because your spouse died before August 21, 1996.

Adjusted Investment in the Contract

The total expected return, as previously figured (in Example 2 under Different payments to survivor), is $169,680. The exclusion percentage of 18.0% ($30,576 ÷ $169,680) applies to the annuity payments you and each of your children receive. Each full year, $864 (18.0% × $4,800) will be tax free to you, and you must include $3,936 in your income tax return. Each year, until age 18, $324 (18.0% × $1,800) of each of your payments will be tax free and each must include the balance, $1,476, as income on their own income tax return.

Part-year payments.

If you receive payments for only part of a year, apply the exclusion percentage to the first regular periodic payment and multiply the result by the number of payments received during the year.

If you receive amounts during the year that represent 12 payments, one for each month in that year, and an amount that represents payments for months in a prior year, apply the exclusion percentage to the first regular periodic payment, and multiply the result by the number of payments the amounts received represent. For instance, if you received amounts during the year that represent the 12 payments for that year plus an amount that represents three payments for a prior year, multiply that amount by the 15 (12 + 3) payments received that year.

If you received a fractional payment, follow Step 5, discussed earlier. This gives you the tax-free part of your total payment.

Example.

On September 28, you bought an annuity contract for $22,050 that will give you $125 a month for life, beginning October 30. The applicable multiple from Table V is 23.3 (age 61). Your expected return is $34,950 ($125 × 12 × 23.3). Your investment in the contract of $22,050, divided by the expected return of $34,950, equals 63.1%. Each payment received will consist of 63.1% return of cost and 36.9% taxable income, until the net cost of the contract is fully recovered. During the first year, you receive three payments of $125, or $375, of which $236.63 (63.1% × $375) is a return of cost. The remaining $138.37 is included in income.

Increase in annuity payments.

The tax-free amount remains the same as the amount figured at the annuity starting date, even if the payment increases. All increases in the installment payments are fully taxable.

However, if your annuity payments are scheduled to increase at a definite date in the future, you must figure the expected return for that annuity using the method described in section 1.72-5(a)(5) of the regulations.

Example.

Your spouse died while still employed and, as the beneficiary, you began receiving an annuity of $147 per month. In figuring the taxable part, you elect to use Tables V through VIII. The cost of the contract was $7,938, consisting of the sum of your spouse’s net contributions adjusted for any refund feature. Your expected return as of the annuity starting date is $35,280 (age 65, multiple of 20.0 × $1,764 annual payment). The exclusion percentage is $7,938 ÷ $35,280, or 22.5%. During the year, you received 11 monthly payments of $147, or $1,617. Of this amount, 22.5% × $147 × 11 ($363.83) is tax free as a return of cost and the balance of $1,253.17 is taxable.

Later, because of a cost-of-living increase, your annuity payment was increased to $166 per month, or $1,992 a year (12 × $166). The tax-free part is still only 22.5% of the annuity payments as of the annuity starting date (22.5% × $147 × 12 = $396.90 for a full year). The increase of $228 ($1,992 − $1,764 (12 × $147)) is fully taxable.

Variable annuities.

For variable annuity payments, figure the amount of each payment that is tax free by dividing your investment in the contract (adjusted for any refund feature) by the total number of periodic payments you expect to get under the contract.

If the annuity is for a definite period, you determine the total number of payments by multiplying the number of payments to be made each year by the number of years you will receive payments. If the annuity is for life, you determine the total number of payments by using a multiple from the appropriate actuarial table.

Example.

You purchased a variable annuity at age 65. The total cost of the contract was $12,000. The annuity starting date is January 1 of the year of purchase. Your annuity will be paid, starting July 1, in variable annual installments for your life. The tax-free amount of each payment until you have recovered the cost of your contract is:

If your first payment is $920, you include only $320 ($920 − $600) in your gross income.

If the tax-free amount for a year is more than the payments you receive in that year, you may choose when you receive the next payment to refigure the tax-free part. Divide the amount of the periodic tax-free part that is more than the payment you received by the remaining number of payments you expect. The result is added to the previously figured periodic tax-free part. The sum is the amount of each future payment that will be tax free.

Example.

Using the facts of the previous example, assume that after the $920 payment, you received $500 in the following year and $1,200 in the year after that. You don’t pay tax on the $500 (second year) payment because $600 of each annual pension payment is tax free. Since the $500 payment is less than the $600 annual tax-free amount, you may choose to refigure the tax-free part when you receive the $1,200 (third year) payment, as follows:

If you choose to refigure your tax-free amount, you must file a statement with your income tax return stating that you are refiguring the tax-free amount in accordance with the rules of Regulations section 1.72-4(d)(3). The statement must also show the following information.

1. The annuity starting date and your age on that date.

2. The first day of the first period for which you received an annuity payment in the current year.

3. Your investment in the contract as originally figured.

4. The total of all amounts received tax free under the annuity from the annuity starting date through the first day of the first period for which you received an annuity payment in the current tax year.

Exclusion Limits

Your annuity starting date determines the total amount of annuity income that you can exclude from income over the years.

Exclusion limited to net cost.

If your annuity starting date is after 1986, the total amount of annuity income that you can exclude over the years as a return of your cost can’t exceed your net cost (figured without any reduction for a refund feature). This is the unrecovered investment in the contract as of the annuity starting date.

If your annuity starting date is after July 1, 1986, any unrecovered net cost at your (or last annuitant's) death is allowed as an other itemized deduction on the final return of the decedent.

Example 1.

Your annuity starting date is after 1986. Your total cost is $12,500, and your net cost is $10,000, taking into account certain adjustments. There is no refund feature. Your monthly annuity payment is $833.33. Your exclusion ratio is 12% and you exclude $100 a month. Your exclusion ends after 100 months, when you have excluded your net cost of $10,000. Thereafter, your annuity payments are fully taxable.

Example 2.

The facts are the same as in Example 1, except that there is a refund feature, and you die after 5 years with no surviving annuitant. The adjustment for the refund feature is $1,000, so the investment in the contract is $9,000. The exclusion ratio is 10.8%, and your monthly exclusion is $90. After 5 years (60 months), you have recovered tax free only $5,400 ($90 x 60). An itemized deduction for the unrecovered net cost of $4,600 ($10,000 net cost minus $5,400) may be taken on your final income tax return. Your unrecovered investment is determined without regard to the refund feature adjustment, discussed earlier, under Adjustments.

Exclusion not limited to net cost.

If your annuity starting date was before 1987, you could continue to take your monthly exclusion for as long as you receive your annuity. If you choose a joint and survivor annuity, your survivor continues to take the survivor’s exclusion figured as of the annuity starting date. The total exclusion may be more than your investment in the contract.

Using the guidance

Keep the documents that establish the dates, amounts, and circumstances described above. References to other chapters, forms, worksheets, or earlier and later sections refer to the linked IRS publication. Check the full publication and its updates before relying on a rule for a different tax year or a situation not addressed here.

Sources and further reading

• Publication 939 (12/2025), General Rule for Pensions and Annuities: Taxation of Periodic Payments — Computation Under the General Rule — Internal Revenue Service; 2025 edition.

The cited U.S. government text is in the public domain. Source accessed October 28, 2026. Fynoptic has organized this material for educational use and is independent of, and not endorsed by, the IRS.