R.A. Primeau (613)957-2127
May 5, 1986
Dear Sir:
Re: Taxation of Deferred Annuities
This is in reply to your letter of January 20, 1986.
You have presented us with a hypothetical situation in which a taxpayer made payments to a non-registered flexible-premium deferred annuity in 1978, 1979, and 1980. We understand that the annuity is not a prescribed annuity contract, that there has been no election made under subsection 12.2(4) of the Income Tax Act (the "Act") to report the accrual income on an annual basis, and therefore that the "third anniversary" accrual rules contained in subsection 12.2(3) of the Act apply. By virtue of paragraph 12.2(11)(b) of the Act, the first "third anniversary" date is December 31, 1987.
You have also informed us that the taxpayer has retired in 1986 and plans to annuitize the contract to provide a monthly income for life.
In any taxation year which is not a "third anniversary" year, for example, 1986, 1988, 1989, 1991, 1992, and so on, paragraph 56(1)(d.1) of the Act will apply to tax the taxpayer on the lesser of the total annuity payments which he receives in that year and the amount by which the "accumulating fund" at the end of that year exceeds the aggregate of the "adjusted cost basis" of the contract at the end of that year and the amount at the end of that year of any "unallocated Income which accrued before 1982". In any taxation year which is "third anniversary" year, for example, 1987, 1990, 1993, and so in, subsection 12.2(3) of the Act will apply to tax the taxpayer in the amount by which the "accumulating fund" on that "third anniversary" exceeds the aggregate of the "adjusted cost basis" of the contract on that "third anniversary" and the amount on that "third anniversary" of any "unallocated income which accrued before 1982".
The rules for calculating the "accumulating fund" are set out in subsection 307(1) of the Income Tax Regulations (the "Regulations"), for calculating the "adjusted cost basis" in paragraph 148(9)(a) of the Act, and for calculating the "unallocated income which accrued before 1982" in subsection 305(1) of the Regulations.
A good commentary on and illustration of the amounts which are taxable over the payout years of an annuity contract in accordance with the above-mentioned provisions of the Act and Regulations is contained on pages 925 to 929 of an article entitled "New Income Tax Rules for Holders of Life Insurance Policies and Annuities" by Alan Macnaughton. This article is contained in the November-December, 1983 issue of the Canadian Tax Journal (Volume 31, Number 6).
We trust that the above will assist you in dealing with this matter.
Yours truly,
Wm. R. McColm for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch