Allocation of basis in annuitized IRA

Submitted by Michael Kelsall on Thu, 2015-05-21 16:15

Assume taxpayer has two IRAs: IRA 1 = $150,000, IRA2 = $50,000
Taxpayer has aggregated basis of $20,000.
Taxpayer elects to annutize IRA2.
How is the basis in the aggregated IRAs allocated to the annuitized IRA?
How is the basis allocate to the payment stream from the annuitized iRA?

First thought is that the basis in the aggregated IRAs is allocated pro-rata between annuitized anad non-annuitized accounts at the time of annuitization. This would allocate $5,000 in basis to the annuitized IRA ($50k/($150k+$50k))*$20k

But how would basis be allocated to the annuity payments?
Would we aallocate basis to the payments based on taxpayer’s life expectancy under the Uniform Table?
Would we allocate basis based on the simplified method under §72(d)?

Or do we not allocate basis to the annuitized account but use Form 8606 each year, thus accelerating the recognition of basis (assumning the annuitization results in larger payments than would normally be taken under the Uniform table for RMDs and the fair market cvalue is reduced by the annuitized amnount)?

Looking forward to any thoughts on this.



Submitted by Alan - IRA critic on Thu, 2015-05-21 17:53

  • There are no IRS Regs on this, which leaves the taxpayer in a position of having to apply a logical and consistent method to the basis recovery. The situation is similar to the RMD dilemma on annuitized accounts since the account no longer has a year end value. The general consensus is that annuitized IRAs and other IRAs are treated as separate accounts for RMD purposes, but if you also treat them separately for basis recovery, then tax reporting will require two 8606 forms with the return in the same manner as if a taxpayer had an owned IRA and an inherited IRA, each with it’s own basis.
  • Before determining an equitable method of reporting the annuitized IRA basis recovery on it’s own 8606, the insurer should be asked if they are going to issue a 5498 reporting an account value. Apparently, some companies have been doing this, although I don’t know if they were asked to by the IRS or how they figure it. But if the IRS is going to receive a 5498 showing a year end value, then the 8606 should report it on line 6, and the non taxable amount of the annual distribution calculated accordingly.
  • If the insurer does NOT report year end value of the IRA annuity, then there may be other equitable ways to calculate the basis recovery, perhaps consolidating under a single 8606 for easier tax support and using the combined basis, but improvising the year end value of the annuity to add it to the other IRA value.
  • Good chance the IRS will not question the approach as long as it does not recover basis in an accelerated manner.

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