Simplified Method - Ballance of cost to be recovered

[LB641]

My wife and I receive 1099-R city pensions. Each year we complete the Simplified Method form to recover money. Every year we recover about 100-200 dollars, of a Ballance To Be Recovered of $7K - $22K. At this rate of recovery, we will be dead before we recover the entire balance.  If we owe the IRS, we have to pay 100% right away. Not in yearly installment that would take 20 years. Why does the IRS only permit us to recover a few hundred dollars each year, and not the total amount? Or better yet, if we owe, why can't we apply the recovery amount that has not been recovered, towards our taxes owed?  See attached

[BillM223]

The Simplified Method was developed to, well, simplify things. This is because the General Rule calculations can be quite complex, not just for the taxpayer, but for the IRS to check it. This does not mean that the Simplified Method results in a better outcome for the taxpayer (although it might).

The Simplified Method is pretty much the same calculation for a broad spectrum of pensions and annuities.

"Why does the IRS only permit us to recover a few hundred dollars each year, and not the total amount? Or better yet, if we owe, why can't we apply the recovery amount that has not been recovered, towards our taxes owed?"

Unfortunately, the answer lies with Congress. The first place to start looking in Title 26  (the Internal Revenue Code) at 26 CFR § 1.61-11 - Pensions.

Then you would have to go search for your particular situation in the Cross References at the bottom.

Most things are not the fault of the IRS - they are mandated by Congress and the IRS has to struggle to figure out a way to implement whatever Congress appeared to mandate.

[LB641]

Thank you kindly for the reply. Unfortunately, not being a tax expert nor lawyer, much of the language is difficult to fully understand. Just using simple common-sense logic, one wonders why we have to pay the IRS 100% and immediately when we owe? But now that the IRS has funds my wife and I need to recover, that range from 7K to 22K, why does the IRS only permit a recovery of $100+, over 20 years? We will never see a full recovery of our money. And since we owe at year's end, why can't we apply that towards the amount we are recovering from the IRS? Where is that rule, that prevents a 100% immediate recovery, or a better rate of recovery, and for a shorter time period?  And why not permit us to use that recovery sum, to apply towards our taxes owed? That just seems logical. Trying to find out if there is a way, and if not, why not?  Again, much thanks.  LB&SW-B

[BillM223]

"why does the IRS only permit a recovery of $100+, over 20 years?" Since I cannot see your private tax data, I don't have an answer; however, I would imagine that if your life span is estimated to be 20 years (based on the IRS tables), then you should be able to recover all of our "cost" or "basis" in that timeframe.

To see you say that you have a "cost" or "basis" or 7k to 22k but the nontaxable portion each year is only 100 to 200 dollars, I have to wonder if something has been entered incorrectly, because the intent of the law is to enable you to recover your cost or basis over your life span.

Is it possible that there is confusion on what "cost" or "basis" is? This is the sum of after-tax dollars that you contributed to your city plan while you were employed. Many retirees have no cost or basis in their pensions, so they are taxed on 100% of their pensions. So are you saying that you and/or your spouse contributed 7k to 22k in after-tax dollars to your pension while you were working?

"Where is that rule, that prevents a 100% immediate recovery, or a better rate of recovery, and for a shorter time period?"

It is buried in that tax code that I showed you earlier. There will not be a user-friendly version of the tax code, just as other laws are incomprehensible to the layman and have to be interpreted by lawyers. This requirement of interpreters for the law is dictated by the fact that the law must be precise while the English language is not precise.

You ask "where is that rule", and the answer is, "It's right here in the Simplified Method" which is applied to most qualified plans.

If you want, you can share with us the data that TurboTax asks for, such as plan start date, number of payments per year, your cost or basis, and the other questions that TurboTax asks in the 1099-R interview. Perhaps I will be able to spot something.

[LB641]

Thank you again.

Mine started in 2011. My wife's started in 2012.

We followed instructions and questions, and entered the data as requested by TT. Line items 1 - 18 of the simplified form using TT.

With 21,000, and a yearly recovery of 1,000, it will take 21 years for me to recover. I don't believe I have 21 years in me.

With 7,000 and a yearly recovery of 300, it will take my wife 23 years to recover.

The simplified form is checked and verified each year, and accepted by the IRS.

Is it law that when we owe the IRS, we have to pay 100% immediately. No recovery over 20 years.

Is it law, that when we owe taxes at the end of the year, we can't apply what the IRS owes us, to that bill?

Seem to be a one-way street. Not sure either one of us will ever see 100% of our recovery.

Is it also law, that the recovery amount can't be increased? Who determines the recovery amount, and over what time period?  Is there no appeal or examination request for this? Or is it baked into law, in the IRS advantage?

[BillM223]

Please read the section starting on page 13 in Pub 575 under Simplified Method and go look at Worksheet A for the calculation. This will allow you to see exactly how the calculation is done.

"With 21,000, and a yearly recovery of 1,000, it will take 21 years for me to recover. I don't believe I have 21 years in me." - If I am not mistaken, you have already received 15 years worth of annuity payments ("Mine started in 2011"), so you should have recovered the large portion of the "cost" or "basis" already (which I think was your point).

Please understand that this whole process is not to the advantage of the IRS, but to that of Congress, the fellows who write and pass the underlaying laws on which the Tax Code is based. It's not like the IRS employees or department collect a percentage (unlike, say, tax collectors in the New Testament who paid themselves out of what they collected).

More importantly, the only people who can change the process are your elected representatives.

 So if you have a question on a specific line on Worksheet A, please let me know.

[LB641]

Thank you

Yes mine started in 2011 at $35K +. As of now, I still have $21K yet to recover, At 1K a year, I am looking at another 21 years to fully recover.  Wife is in same situation. She still has $8K to recover @ $340 a year. About another 20+/- years. Not sure either one of us will ever see 100% of our recovery at this slow minimal rate.

What we are wondering is,

Is it law, that when we owe taxes at the end of the year, we can't apply what the IRS owes us, to that bill?

Is it also law, that the recovery amount can't be increased? Who determines the recovery amount, and over what time period?  Is there no appeal or examination request for this?  Or is the time line, rate of recover, and recovery amount determined by law and the Simplified Worksheet?

All we can do on the work sheet is properly and accurately answer the 1-18 questions, as they are asked, and based on our 1099-R's.

Thank You Kindly

[BillM223]

To help you understand how it works, let's take some simple cases.

On Worksheet A in Pub 575, let's assume the taxpayer was 55 years old on the annuity start date. We see on "Table 1 for Line 3 Above" that the denominator is 360. Assuming that 360 represents number of months, this is 30 years. 30 years plus 55 is 85 years.

Now let's assume that the taxpayer is 60 years old at the annuity start date. The denominator drops to 310, or 25.8 years. 25.8 years plus 60 years of age is 85.8 years, about the same as the previous example. 

If you do each of these, you will find that the result is about 85 years for each one. And what is so magical about 85? If you look at the actuarial tables maintained by the Social Security Administration (see their calculator here), you will see that for men born about the time of yours and mine birthdays that the actuarial longevity is about 85 years.

For a couple where the spouse can inherit the pension/annuity ("Table 2 for Line 3 Above"), it's more complicated, but the principle is the same.

Why does this happen? Because you received a tax benefit when your employer contributed (tax-deferred) to your pension/annuity? You receive a secondary benefit when earnings on these contributions grow tax-deferred as well. The presumption of the law is that this tax benefit must be eventually paid back, i.e., be taxed. However, for after-tax amounts that you contributed in addition to the employer's contribution, since that amount was already taxed, when you receive it as part of your pension/annuity distributions, it is not taxed.

Please note that a non-qualified annuity (i.e., lesser regulated by the government) can be set up so that all of the cost or basis is returned to the pension/annuity beneficiary before any taxable income is. For example, if you bought a non-qualified annuity for $70,000, the terms of the annuity might be to do a constant pay out per year (say, $7k) such that your return  (the $7k) is tax-free until the original cost/basis is exhausted, and then the insurance company/annuity company continues to pay you taxable earnings until your death.

I do not know of a way to convert pension or annuity from a qualified plan to such a non-qualified annuity or if it is even possible. Perhaps some one else will come along and add to this discussion.

One thing you might do is contact the plan administrator and ask if there is a lump-sum option, where you would receive the entire amount due (however they calculate that). This is a good news/bad news plan, though, since your higher income may push you into a higher tax bracket...and then you would get no more income at all from this source.

[LB641]

Again, thank you for staying with us on this conversation, as we continue to learn and understand.  We wonder why others in this situation have not come up with the same questions. It is puzzling. I guess when it comes to the IRS, no one wants to question or rock the boat 🙂

It looks like on six, they combined or added or ages. Not sure what seven age factor/payment months means.

Interesting, is the recovery amount allowed is the exact same every year. It does not increase or decrease.

Assuming all males live to 85 is a stretch. I know it is not true in our family. Not even close. But then why force the recovery to age 85? 

And the question heard most, is why, if they owe us, do they get 21-30 years to pay it back. If we owe the IRS, we pay immediate, and 100%.

The next question, is if they owe, why can't we apply taxes owed, towards what they owe us? Fair for both.

again, we thank you kindly. Hopefully this conversation is helping others with the same questions.  S&L 

[BillM223]

But then why force the recovery to age 85? 

Because the Medicare and Social Security departments have many actuaries and huge amounts of data showing on the average that people born in the 1950s (the decade I chose for purposes of the explanation) live until 85 (I assume that they have excluded anyone who has already died, that is, if you are still alive now, you are likely to live to 85).

As the ssa.gov website says, this does not (and cannot) take into account any particular family or medical history.

And the question heard most, is why, if they owe us, do they get 21-30 years to pay it back. If we owe the IRS, we pay immediate, and 100%.

Ask your Congressperson - they made the rules.

The next question, is if they owe, why can't we apply taxes owed, towards what they owe us?

The IRS doesn't owe you anything, they are just declining to tax you on the cost or basis that you recovered each year.