which were included in gross income and rein-
vested in the contract), minus
‘‘(B) the aggregate amount received under
the contract before such date, to the extent that
such amount was excludable from gross income
under this subtitle or prior income tax laws.
‘‘(2) OTHER
TERMS
USED
IN
SUBSECTION
(b).—Calculations under subsections (a) and (b)
shall be made in accordance with regulations pre-
scribed by the Secretary, which regulations shall
generally be consistent with the section 72 of the In-
ternal Revenue Code of 1986.
‘‘(d) SPECIAL RULES FOR QUALIFIED EMPLOYER
RETIREMENT PLANS.—
‘‘(1) SIMPLIFIED METHOD OF TAXING ANNUITY
PAYMENTS.—
‘‘(A) IN
GENERAL.—In the case of any
amount received as an annuity under a quali-
fied employer retirement plan—
‘‘(i) subsection (b) shall not apply,
and
‘‘(ii) the investment in the contract
shall be recovered as provided in this para-
graph.
‘‘(B) METHOD
OF
RECOVERING
INVEST-
MENT IN CONTRACT.—
‘‘(i) 
IN
GENERAL.—Gross 
income
shall not include so much of any monthly
annuity payment under a qualified em-
ployer retirement plan as does not exceed
the amount obtained by dividing—
‘‘(I) the investment in the con-
tract (as of the annuity starting date),
by
‘‘(II) the number of anticipated
payments determined under the table
contained in clause (iii) (or, in the
case of a contract to which subsection
(c)(3)(B) applies, the number of
monthly annuity payments under such
contract).
‘‘(ii) CERTAIN RULES MADE APPLICA-
BLE.—Rules similar to the rules of para-
graphs (2) and (3) of subsection (b) shall
apply for purposes of this paragraph.
‘‘(iii) NUMBER OF ANTICIPATED PAY-
MENTS.—If the annuity is payable over the
life of a single individual, the number of
anticipated payments shall be determined
as follows:
If the age of the annuitant on
the annuity starting date
is:
The number:
Not more than 55 ..........................
360
More than 55 but not more than
60.
310
More than 60 but not more than
65.
260
More than 65 but not more than
70.
210
More than 70 .................................
160
‘‘(iv) NUMBER OF ANTICIPATED PAY-
MENTS WHERE MORE THAN ONE LIFE.—If
the annuity is payable over the lives of
more than 1 individual, the number of an-
ticipated payments shall be determined as
follows:
If the combined ages of the
annuitants are:
The number:
Not more than 110 ........................
410
More than 110 but not more than
120.
360
More than 120 but not more than
130.
310
More than 130 but not more than
140.
260
More than 140 ...............................
210
‘‘(C) SPECIAL
RULE
WHERE
LUMP
SUM
PAID
IN
CONNECTION
WITH
COMMENCEMENT
OF ANNUITY PAYMENTS.—If, in connection with
the commencement of annuity payments under
any qualified employer retirement plan, the tax-
payer receives a lump sum payment—
‘‘(i) such payment shall be taxable
under subsection (e) as if received before
the annuity starting date, and
‘‘(ii) the investment in the contract
for purposes of this paragraph shall be de-
termined as if such payment had been so
received.
‘‘(D) EXCEPTION.—This paragraph shall
not apply in any case where the primary annu-
itant has attained age 75 on the annuity start-
ing date unless there are fewer than 5 years of
guaranteed payments under the annuity.
‘‘(E) ADJUSTMENT WHERE ANNUITY PAY-
MENTS
NOT
ON
A
MONTHLY
BASIS.—In any
case where the annuity payments are not made
on a monthly basis, appropriate adjustments in
the application of this paragraph shall be made
to take into account the period on the basis of
which such payments are made.
‘‘(F) QUALIFIED EMPLOYER RETIREMENT
PLAN.—For purposes of this paragraph, the
term ‘qualified employer retirement plan’ means
any plan or contract described in paragraph
(1), (2), or (3) of section 4974(c).
‘‘(2) TREATMENT
OF
EMPLOYEE
CONTRIBU-
TIONS
UNDER
DEFINED
CONTRIBUTION
PLANS.—
For purposes of this section, employee contributions
(and any income allocable thereto) under a defined
contribution plan may be treated as a separate con-
tract.
‘‘(e) AMOUNTS NOT RECEIVED AS ANNUITIES.—
‘‘(1) APPLICATION OF SUBSECTION.—
‘‘(A) IN GENERAL.—This subsection shall
apply to any amount which—
‘‘(i) is received under an annuity, en-
dowment, or life insurance contract, and
‘‘(ii) is not received as an annuity,
if no provision of this subtitle (other than this
subsection) applies with respect to such
amount.
‘‘(B) DIVIDENDS.—For purposes of this
section, any amount received which is in the na-
ture of a dividend or similar distribution shall
be treated as an amount not received as an an-
nuity.
‘‘(2) GENERAL RULE.—Any amount to which
this subsection applies—
‘‘(A) if received on or after the annuity
starting date, shall be included in gross income,
or
‘‘(B) if received before the annuity starting
date—
‘‘(i) shall be included in gross income
to the extent allocable to income on the
contract, and
‘‘(ii) shall not be included in gross in-
come to the extent allocable to the invest-
ment in the contract.
‘‘(3) ALLOCATION
OF
AMOUNTS
TO
INCOME
AND
INVESTMENT.—For purposes of paragraph
(2)(B):
‘‘(A) Any amount to which this subsection
applies shall be treated as allocable to income
on the contract to the extent that such amount
does not exceed the excess (if any) of—
‘‘(i) the cash value of the contract
(determined without regard to any sur-
render charge) immediately before the
amount is received, over
‘‘(ii) the investment in the contract at
such time.
‘‘(B) Any amount to which this subsection
applies shall be treated as allocable to invest-
ment in the contract to the extent that such
amount is not allocated to income under sub-
paragraph (A).
‘‘(4) SPECIAL
RULES
FOR
APPLICATION
OF
PARAGRAPH
(2)(B).—For purposes of paragraph
(2)(B):
‘‘(A) 
LOANS
TREATED
AS
DISTRIBU-
TIONS.—If, during any taxable year, an
individual—
‘‘(i) receives (directly or indirectly)
any amount as a loan under any contract
to which this subsection applies, or
‘‘(ii) assigns or pledges (or agrees to
assign or pledge) any portion of the value
of any such contract,
such amount or portion shall be treated as re-
ceived under the contract as an amount not re-
ceived as an annuity. The preceding sentence
shall not apply for purposes of determining in-
vestment in the contract, except that the invest-
ment in the contract shall be increased by any
amount included in gross income by reason of
the amount treated as received under the pre-
ceding sentence.
‘‘(B) TREATMENT
OF
TRANSFERS
WITH-
OUT ADEQUATE CONSIDERATION.—
‘‘(i) IN
GENERAL.—If an individual
who holds an annuity contract transfers it
without full and adequate consideration,
such individual shall be treated as receiv-
ing an amount equal to the excess of—
‘‘(I) the cash surrender value of
such contract at the time of transfer,
over
‘‘(II) the investment in such con-
tract at such time,
under the contract as an amount not re-
ceived as an annuity.
‘‘(ii) 
EXCEPTION
FOR
CERTAIN
TRANSFERS
BETWEEN
SPOUSES
OR
FORMER
SPOUSES.—Clause (i) shall not
apply to any transfer to which section
77(c) (relating to transfers of property be-
tween spouses or incident to divorce) ap-
plies.
‘‘(iii) ADJUSTMENT
TO
INVESTMENT
IN CONTRACT OF TRANSFEREE.—If under
clause (i) an amount is included in the
gross income of the transferor of an annu-
ity contract, the investment in the contract
of the transferee in such contract shall be
increased by the amount so included.
‘‘(5) RETENTION OF EXISTING RULES IN CER-
TAIN CASES.—Paragraph (5) of section 72(e) of the
Internal Revenue Code of 1986 shall apply to con-
tracts described in subparagraph (B) of such para-
graph to the extent provided therein.
‘‘(6) INVESTMENT
IN
THE
CONTRACT.—For
purposes of this subsection, the investment in the
contract as of any date is—
‘‘(A) the aggregate amount of premiums or
other consideration paid for the contract before
such date, minus
‘‘(B) the aggregate amount received under
the contract before such date, to the extent that
such amount was excludable from gross income
under this subtitle or prior income tax laws.
‘‘(7) APPLICATION
OF
PARAGRAPH
(2)(B)
TO
QUALIFIED PLANS.—
‘‘(A) IN GENERAL.—Notwithstanding any
other provision of this subsection, in the case of
any amount received before the annuity starting
date from a trust or contract described in para-
graph (5)(D), paragraph (2)(B) shall apply to
such amounts.
‘‘(B) 
ALLOCATION
OF
AMOUNT
RE-
CEIVED.—For purposes of paragraph (2)(B),
the amount allocated to the investment in the
contract shall be the portion of the amount de-
scribed in subparagraph (A) which bears the
same ratio to such amount as the investment in
the contract bears to the account balance. The
determination under the preceding sentence
shall be made as of the time of the distribution
or at such other time as the Secretary may pre-
scribe.
‘‘(C) 
TREATMENT
OF
FORFEITABLE
RIGHTS.—If an employee does not have a non-
forfeitable right to any amount under any trust
or contract to which subparagraph (A) applies,
such amount shall not be treated as part of the
account balance.
‘‘(D) INVESTMENT IN THE CONTRACT BE-
FORE 1987.—In the case of a plan which on
May 5, 1986, permitted withdrawal of any em-
ployee contributions before separation from
service, subparagraph (A) shall apply only to
the extent that amounts received before the an-
nuity starting date (when increased by amounts
previously received under the contract after De-
cember 31, 1986) exceed the investment in the
contract as of December 31, 1986.
‘‘(8) TREATMENT OF MODIFIED ENDOWMENT
CONTRACTS.—
‘‘(A) IN GENERAL.—Notwithstanding para-
graph (5)(C), in the case of any modified en-
dowment contract (as defined in section
7702A)—
‘‘(i) paragraphs (2)(B) and (4)(A)
shall apply, and
‘‘(ii) in applying paragraph (4)(A),
‘any person’ shall be substituted for ‘an in-
dividual’.
‘‘(B) TREATMENT
OF
CERTAIN
BURIAL
CONTRACTS.—Notwithstanding 
subparagraph
(A), paragraph (4)(A) shall not apply to any as-
signment (or pledge) of a modified endowment
contract if such assignment (or pledge) is solely
to cover the payment of expenses referred to in
section 7702(e)(2)(C)(iii) and if the maximum
death benefit under such contract does not ex-
ceed $25,000.
‘‘(9) ANTI-ABUSE RULES.—
‘‘(A) IN GENERAL.—For purposes of deter-
mining the amount includible in gross income
under this subsection—
‘‘(i) all modified endowment contracts
issued by the same company to the same
policyholder during any calendar year shall
be treated as 1 modified endowment con-
tract, and
‘‘(ii) all annuity contracts issued by
the same company to the same policyholder
during any calendar year shall be treated
as 1 annuity contract.
The preceding sentence shall not apply to any
contract described in paragraph (5)(D).
‘‘(B) REGULATORY AUTHORITY.—The Sec-
retary may by regulations prescribe such addi-
tional rules as may be necessary or appropriate
to prevent avoidance of the purposes of this
subsection through serial purchases of contracts
or otherwise.
‘‘(f) SPECIAL RULES FOR COMPUTING EMPLOYEES’
CONTRIBUTIONS.—In computing, for purposes of sub-
section (c)(1)(A), the aggregate amount of premiums or
other consideration paid for the contract, and for purposes
100
of subsection (e)(6), the aggregate premiums or other con-
sideration paid, amounts contributed by the employer shall
be included, but only to the extent that—
‘‘(1) such amounts were includible in the gross
income of the employee under this subtitle or prior
income tax laws; or
‘‘(2) if such amounts had been paid directly to
the employee at the time they were contributed, they
would not have been includible in the gross income
of the employee under the law applicable at the time
of such contribution.
‘‘(g) RULES FOR TRANSFEREE WHERE TRANSFER
WAS FOR VALUE.—Where any contract (or any interest
therein) is transferred (by assignment or otherwise) for
a valuable consideration, to the extent that the contract
(or interest therein) does not, in the hands of the trans-
feree, have a basis which is determined by reference to
the basis in the hands of the transferor, then—
‘‘(1) for purposes of this section, only the ac-
tual value of such consideration, plus the amount of
the premiums and other consideration paid by the
transferee after the transfer, shall be taken into ac-
count in computing the aggregate amount of the
premiums or other consideration paid for the con-
tract;
101
‘‘(2) for purposes of subsection (c)(1)(B), there
shall be taken into account only the aggregate
amount received under the contract by the trans-
feree before the annuity starting date, to the extent
that such amount was excludable from gross income
under this subtitle or prior income tax laws; and
‘‘(3) the annuity starting date is January 1,
1954, or the first day of the first period for which
the transferee received an amount under the con-
tract as an annuity, whichever is the later.
‘‘(h) OPTION TO RECEIVE ANNUITY IN LIEU OF
LUMP SUM.—If—
‘‘(1) a contract provides for payment of a lump
sum in full discharge of an obligation under the con-
tract, subject to an option to receive an annuity in
lieu of such lump sum;
‘‘(2) the option is exercised within 60 days after
the day on which such lump sum first became pay-
able; and
‘‘(3) part or all of such lump sum would (but
for this subsection) be includible in gross income by
reason of subsection (e)(1),
then, for purposes of this subtitle, no part of such lump
sum shall be considered as includible in gross income at
the time such lump sum first became payable.
102
‘‘(i) INTEREST.—Notwithstanding any other provi-
sion of this section, if any amount is held under an agree-
ment to pay interest thereon, the interest payments shall
be included in gross income.
‘‘(j) FACE-AMOUNT CERTIFICATES.—For purposes of
this section, the term ‘endowment contract’ includes a
face-amount certificate, as defined in section 2(a)(15) of
the Investment Company Act of 1940 (15 U.S.C., sec.
80a–2), issued after December 31, 1954.
‘‘(k) SPECIAL RULES APPLICABLE TO EMPLOYEE
ANNUITIES
AND
DISTRIBUTIONS
UNDER
EMPLOYEE
PLANS.—
‘‘(1) COMPUTATION
OF
CONSIDERATION
PAID
BY THE EMPLOYEE.—In computing—
‘‘(A) the aggregate amount of premiums or
other consideration paid for the contract for
purposes of subsection (c)(1)(A) (relating to the
investment in the contract), and
‘‘(B) the aggregate premiums or other con-
sideration paid for purposes of subsection (e)(6)
(relating to certain amounts not received as an
annuity),
any amount allowed as a deduction with respect to
the contract under section 404 which was paid while
the employee was an employee within the meaning of
103
section 401(c)(1) shall be treated as consideration
contributed by the employer, and there shall not be
taken into account any portion of the premiums or
other consideration for the contract paid while the
employee was an owner-employee which is properly
allocable (as determined under regulations pre-
scribed by the Secretary) to the cost of life, accident,
health, or other insurance.
‘‘(2) LIFE INSURANCE CONTRACTS.—
‘‘(A) This paragraph shall apply to any life
insurance contract—
‘‘(i) purchased as a part of a plan de-
scribed in section 403(a), or
‘‘(ii) purchased by a trust described in
section 401(a) which is exempt from tax if
the proceeds of such contract are payable
directly or indirectly to a participant in
such trust or to a beneficiary of such par-
ticipant.
‘‘(B) Any contribution to a plan described
in subparagraph (A)(i) or a trust described in
subparagraph (A)(ii) which is allowed as a de-
duction under section 404, and any income of
a trust described in subparagraph (A)(ii), which
is determined in accordance with regulations
104
prescribed by the Secretary to have been ap-
plied to purchase the life insurance protection
under a contract described in subparagraph
(A), is includible in the gross income of the par-
ticipant for the taxable year when so applied.
‘‘(C) In the case of the death of an indi-
vidual insured under a contract described in
subparagraph (A), an amount equal to the cash
surrender value of the contract immediately be-
fore the death of the insured shall be treated as
a payment under such plan or a distribution by
such trust, and the excess of the amount pay-
able by reason of the death of the insured over
such cash surrender value shall not be includ-
ible in gross income under this section and shall
be treated as provided in section 101.
‘‘(3) PENALTIES
APPLICABLE
TO
CERTAIN
AMOUNTS RECEIVED BY 5-PERCENT OWNERS.—
‘‘(A) This paragraph applies to amounts
which are received from a qualified trust de-
scribed in section 401(a) or under a plan de-
scribed in section 403(a) at any time by an in-
dividual who is, or has been, a 5-percent owner,
or by a successor of such an individual, but only
to the extent such amounts are determined,
105
under regulations prescribed by the Secretary,
to exceed the benefits provided for such indi-
vidual under the plan formula.
‘‘(B) If a person receives an amount to
which this paragraph applies, his tax under this
chapter for the taxable year in which such
amount is received shall be increased by an
amount equal to 10 percent of the portion of
the amount so received which is includible in
his gross income for such taxable year.
‘‘(C) For purposes of this paragraph, the
term ‘5-percent owner’ means any individual
who, at any time during the 5 plan years pre-
ceding the plan year ending in the taxable year
in which the amount is received, is a 5-percent
owner (as defined in section 416(i)(1)(B).
‘‘(4) OWNER-EMPLOYEE
DEFINED.—For pur-
poses of this subsection, the term ‘owner-employee’
has the meaning assigned to it by section 401(c)(3)
and includes an individual for whose benefit an indi-
vidual retirement account or annuity described in
section 408(a) or (b) is maintained. For purposes of
the preceding sentence, the term ‘owner-employee’
shall include an employee within the meaning of sec-
tion 401(c)(1).
106
‘‘(5) MEANING OF DISABLED.—For purposes of
this section, an individual shall be considered to be
disabled if he is unable to engage in any substantial
gainful activity by reason of any medically deter-
minable physical or mental impairment which can be
expected to result in death or to be of long-continued
and indefinite duration. An individual shall not be
considered to be disabled unless he furnishes proof
of the existence thereof in such form and manner
as the Secretary may require.
‘‘(6) DETERMINATION OF INVESTMENT IN THE
CONTRACT IN THE CASE OF QUALIFIED DOMESTIC
RELATIONS ORDERS.—Under regulations prescribed
by the Secretary, in the case of a distribution or
payment made to an alternate payee who is the
spouse or former spouse of the participant pursuant
to a qualified domestic relations order (as defined in
section 414(p)), the investment in the contract as of
the date prescribed in such regulations shall be allo-
cated on a pro rata basis between the present value
of such distribution or payment and the present
value of all other benefits payable with respect to the
participant to which such order relates.
‘‘(l) ANNUITIES UNDER RETIRED SERVICEMAN’S
FAMILY
PROTECTION
PLAN
OR
SURVIVOR
BENEFIT