Investment in the Contract — Adjustments: Annuity Tax Calculations (2025 IRS Guide)

This guide covers “Investment in the Contract — Adjustments” 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

Distributions from your pension or annuity plan may include amounts treated as a recovery of your cost (investment in the contract). If any part of a distribution is treated as a recovery of your cost, that part is tax free.

In figuring how much of your pension or annuity is taxable under the General Rule, you must figure your investment in the contract.

First, find your net cost of the contract as of the annuity starting date (defined later). To find this amount, you must first figure the total premiums, contributions, or other amounts paid. This includes the amounts your employer contributed if you were required to include these amounts in income. It also includes amounts you actually contributed (except amounts for health and accident benefits and deductible voluntary employee contributions).

From this total cost you subtract:

The annuity starting date is the later of the first day of the first period for which you receive payment under the contract or the date on which the obligation under the contract becomes fixed.

Investment in the Contract — Adjustments

If any of the following items apply, adjust (add or subtract) your total cost to find your net cost.

Foreign employment.

If you worked abroad, your cost may include contributions by your employer to the retirement plan, but only if those contributions would be excludable from your gross income had they been paid directly to you as compensation. The contributions that apply are:

1. Contributions before 1963 by your employer,

2. Contributions after 1962 by your employer if the contributions would be excludable from your gross income (not including the foreign earned income exclusion) had they been paid directly to you, or

3. Contributions after 1996 by your employer if you performed the services of a foreign missionary (a duly ordained, commissioned, or licensed minister of a church or a lay person) if the contributions would be excludable from your gross income had they been paid directly to you.

Foreign employment contributions while a nonresident alien.

In determining your cost, special rules apply if you are a U.S. citizen or resident alien who received distributions from a plan to which contributions were made while you were a nonresident alien. Your contributions and your employer's contributions aren’t included in your cost if the contributions:

• Were made based on compensation that was for services performed outside the United States while you were a nonresident alien; and

• Weren’t subject to income tax under the laws of the United States or any foreign country, but only if the contribution would have been subject to income tax if paid as cash compensation when the services were performed.

Death benefit exclusion.

If you are the beneficiary of a deceased employee (or former employee) who died before August 21, 1996, you may qualify for a death benefit exclusion of up to $5,000. The beneficiary of a deceased employee who died after August 20, 1996, won't qualify for the death benefit exclusion.

How to adjust your total cost.

If you are eligible, treat the amount of any allowable death benefit exclusion as additional cost paid by the employee. Add it to the cost or unrecovered cost of the annuity at the annuity starting date. See Example 3 under Computation Under the General Rule, later, for an illustration of the adjustment to the cost of the contract.

Net cost.

Your total cost plus certain adjustments and minus other amounts already recovered before the annuity starting date is your net cost. This is the unrecovered investment in the contract as of the annuity starting date. If your annuity starting date is after 1986, this is the maximum amount that you may recover tax free under the contract.

Refund feature.

Adjustment for the value of the refund feature is only applicable when you report your pension or annuity under the General Rule. Your annuity contract has a refund feature if:

1. The expected return (discussed later) of an annuity depends entirely or partly on the life of one or more individuals,

2. The contract provides that payments will 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 hasn't been paid to the annuitant or annuitants before death, and

3. The payments are a refund of the amount you paid for the annuity contract.

If your annuity has a refund feature, you must reduce your net cost of the contract by the value of the refund feature (figured using Table III or VII at the end of this publication; also see How To Use Actuarial Tables, later) to find the investment in the contract.

Zero value of refund feature.

For a joint and survivor annuity, the value of the refund feature is zero if:

1. Both annuitants are age 74 or younger,

2. The payments are guaranteed for less than 2½ years, and

3. The survivor’s annuity is at least 50% of the first annuitant's annuity.

For a single-life annuity without survivor benefit, the value of the refund feature is zero if:

1. The payments are guaranteed for less than 2½ years; and

2. The annuitant is:

   1. Age 57 or younger (if using the new (unisex) annuity tables),

   2. Age 42 or younger (if male and using the old annuity tables), or

   3. Age 47 or younger (if female and using the old annuity tables).

If you don’t meet these requirements, you will have to figure the value of the refund feature, as explained in the following discussion.

Examples.

Example 1 shows how to figure the value of the refund feature when there is only one beneficiary. Example 2 shows how to figure the value of the refund feature when the contract provides, in addition to a whole life annuity, one or more temporary life annuities for the lives of children. In both examples, the taxpayer elects to use Tables V through VIII. If you need the value of the refund feature for a joint and survivor annuity, write to the IRS as explained under Requesting a Ruling on Taxation of Annuity near the end of this publication.

Example 1.

At age 65, you bought for $21,053 an annuity with a refund feature. You will get $100 a month for life. Your contract provides that if you don’t live long enough to recover the full $21,053, similar payments will be made to your surviving beneficiary until a total of $21,053 has been paid under the contract. In this case, the contract cost and the total guaranteed return are the same ($21,053). Your investment in the contract is figured as follows:

If the total guaranteed return were less than the $21,053 net cost of the contract, you would apply the appropriate percentage from the tables to the lesser amount. For example, if the contract guaranteed the $100 monthly payments for 17 years to your estate or beneficiary if you were to die before receiving all the payments for that period, the total guaranteed return would be $20,400 ($100 × 12 × 17 years). In this case, the value of the refund feature would be $2,856 (14% x $20,400) and your investment in the contract would be $18,197 ($21,053 – $2,856) instead of $17,895.

Example 2.

You died while still employed. Your surviving spouse, age 48, receives $171 a month for life. Your child, age 9, receives $50 a month until reaching age 18. Your contributions to the retirement fund totaled $7,559.45, with interest on those contributions of $1,602.53. The guarantee or total refund feature of the contract is $9,161.98 ($7,559.45 + $1,602.53).

The adjustment in the investment in the contract is figured as follows:

Free IRS help.

If you need to request assistance to figure the value of the refund feature, see Requesting a Ruling on Taxation of Annuity near the end of this publication.

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 — Investment in the Contract — Adjustments — 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.