Publication 721 (2007), Tax Guide to U.S. Civil Service Retirement Benefits

IRS Resources

Publication 721 - Main Contents

Table of Contents

Part I General Information

This part of the publication contains information that can apply to most recipients of civil service retirement benefits.

Refund of Contributions

If you leave federal government service or transfer to a job not under the CSRS or FERS and you are not eligible for an immediate annuity, you can choose to receive a refund of the money in your CSRS or FERS retirement account. The refund will include both regular and voluntary contributions you made to the fund, plus any interest payable.

If the refund includes only your contributions, none of the refund is taxable. If it includes any interest, the interest is taxable unless you roll it over directly into another qualified plan or a traditional individual retirement arrangement (IRA). If you do not have the Office of Personnel Management (OPM) transfer the interest to an IRA or other plan in a direct rollover, tax will be withheld at a 20% rate. See Rollover Rules in Part II for information on how to make a rollover.

Interest is not paid on contributions to the CSRS for service after 1956 unless your service was for more than 1 year but not more than 5 years. Therefore, many employees who withdraw their contributions under the CSRS do not get interest and do not owe any tax on their refund.

If you do not roll over interest included in your refund, it may qualify as a lump-sum distribution eligible for capital gain treatment or the 10-year tax option. If you separate from service before the calendar year in which you reach age 55, it may be subject to an additional 10% tax on early distributions. For more information, see Lump-Sum Distributions and Tax on Early Distributions in Publication 575.

A lump-sum distribution is eligible for capital gain treatment or the 10-year tax option only if the plan participant was born before January 2, 1936.

Tax Withholding and Estimated Tax

The CSRS or FERS annuity you receive is subject to federal income tax withholding, unless you choose not to have tax withheld. OPM will tell you how to make the choice. The choice for no withholding remains in effect until you change it. These withholding rules also apply to a disability annuity, whether received before or after minimum retirement age.

If you choose not to have tax withheld, or if you do not have enough tax withheld, you may have to make estimated tax payments.

You may owe a penalty if the total of your withheld tax and estimated tax does not cover most of the tax shown on your return. Generally, you will owe the penalty for 2008 if the additional tax you must pay with your return is $1,000 or more and more than 10% of the tax to be shown on your 2008 return. For more information, including exceptions to the penalty, see chapter 4 of Publication 505, Tax Withholding and Estimated Tax.

Form CSA 1099R. Form CSA 1099R is mailed to you by OPM each year. It will show any tax you had withheld. File a copy of Form CSA 1099R with your tax return if any federal income tax was withheld.

You also can view and download your Form CSA 1099R by visiting the OPM website at
www.servicesonline.opm.gov. To log in, you will need your retirement CSA claim number and your personal identification number.

Choosing no withholding on payments outside the United States. The choice for no withholding generally cannot be made for annuity payments to be delivered outside the United States and its possessions.

To choose no withholding if you are a U.S. citizen or resident alien, you must provide OPM with your home address in the United States or its possessions. Otherwise, OPM has to withhold tax. For example, OPM must withhold if you provide a U.S. address for a nominee, trustee, or agent (such as a bank) to whom the benefits are to be delivered, but you do not provide your own U.S. home address.

If you do not provide a home address in the United States or its possessions, you can choose not to have tax withheld only if you certify to OPM that you are not a U.S. citizen, a U.S. resident alien, or someone who left the United States to avoid tax. But if you so certify, you may be subject to the 30% flat rate withholding that applies to nonresident aliens. For details, see Publication 519, U.S. Tax Guide for Aliens.

Withholding certificate. If you give OPM a Form W-4P-A, Election of Federal Income Tax Withholding, you can choose not to have tax withheld or you can choose to have tax withheld. The amount of tax withheld depends on your marital status, the number of withholding allowances, and any additional amount you designate to be withheld. If you do not make either of these choices, OPM must withhold as if you were married with three withholding allowances.

To change the amount of tax withholding or to stop withholding, call OPM's Retirement Information Office at 1-888-767-6738 (customers within the local Washington, D.C. calling area must call 202-606-0500), or call Annuitant Express at 1-800-409-6528. No special form is needed. You will need your retirement CSA or CSF claim number, your social security number, and your personal identification number (PIN) when you call. If you have TTY/TDD equipment, call 1-800-878-5707. If you need a PIN, call OPM's Retirement Information Office.

You also can change the amount of withholding or stop withholding online by visiting the OPM website at www.servicesonline.opm.gov. You will need your retirement CSA or CSF claim number and your PIN.

Withholding from certain lump-sum payments. If you leave the federal government before becoming eligible to retire and you apply for a refund of your CSRS or FERS contributions, or you die without leaving a survivor eligible for an annuity, you or your beneficiary will receive a distribution of your contributions to the retirement plan plus any interest payable. Tax will be withheld at a 20% rate on the interest distributed. However, tax will not be withheld if you have OPM transfer (roll over) the interest directly to your traditional IRA or other qualified plan. See Rollover Rules in Part II. If you receive only your contributions, no tax will be withheld.

Withholding from Thrift Savings Plan payments. Generally, a distribution that you receive from the TSP is subject to federal income tax withholding. The amount withheld is:

20% if the distribution is an eligible rollover distribution, or
10% if it is a nonperiodic distribution other than an eligible rollover distribution, or
An amount determined as if you were married with three withholding allowances, unless you submit a withholding certificate (Form W-4P), if it is a periodic distribution.

However, you usually can choose not to have tax withheld from TSP payments other than eligible rollover distributions. By January 31 after the end of the year in which you receive a distribution, the TSP will issue Form 1099-R showing the total distributions you received in the prior year and the amount of tax withheld.

For a detailed discussion of withholding on distributions from the TSP, see Important Tax Information About Payments From Your TSP Account, available from your agency personnel office or from the TSP.

The above document is also available on the TSP website at www.tsp.gov. Select “Forms & Publications,” then select “Publications,” then “Tax Notices.”

Estimated tax. Generally, you must make estimated tax payments for 2008 if you expect to owe at least $1,000 in tax for 2008 (after subtracting your withholding and credits) and you expect your withholding and your credits to be less than the smaller of:

90% of the tax to be shown on your income tax return for 2008, or
100% of the tax shown on your 2007 income tax return (110% of that amount if the adjusted gross income shown on the return was more than $150,000 ($75,000 if your filing status for 2008 will be married filing separately)). The return must cover all 12 months.

You do not have to pay estimated tax for 2008 if you were a U.S. citizen or resident alien for all of 2007 and you had no tax liability for the full 12-month 2007 tax year.

Form 1040-ES contains a worksheet that you can use to help you figure your estimated tax payments. For more information, see chapter 2 in Publication 505.

Filing Requirements

If your gross income, including the taxable part of your annuity, is less than a certain amount, you generally do not have to file a federal income tax return for that year. The gross income filing requirements for the tax year are in the instructions to Form 1040, 1040A, or 1040EZ.

Children. If you are the surviving spouse of a federal employee or retiree and your monthly annuity check includes a survivor annuity for one or more children, each child's annuity counts as his or her own income (not yours) for federal income tax purposes.

If your child can be claimed as a dependent, treat the taxable part of his or her annuity as unearned income when applying the filing requirements for dependents.

Form CSF 1099R. Form CSF 1099R will be mailed to you by January 31 after the end of each tax year. It will show the total amount of the annuity you received in the past year. It also should show, separately, the survivor annuity for a child or children. Only the part that is each individual's survivor annuity should be shown on that individual's Form 1040 or 1040A.

If your Form CSF 1099R does not show separately the amount paid to you for a child or children, attach a statement to your return, along with a copy of Form CSF 1099R, explaining why the amount shown on the tax return differs from the amount shown on Form CSF 1099R.

You also can view and download your Form CSF 1099R by visiting the OPM website at
www.servicesonline.opm.gov. To log in you will need your retirement CSF claim number and personal identification number.

You may request a Summary of Payments, showing the amounts paid to you for your child(ren), from OPM by calling OPM's Retirement Information Office at 1-888-767-6738 (customers within the local Washington, D.C. calling area must call 202-606-0500). You will need your CSF claim number and your social security number when you call.

Taxable part of annuity. To find the taxable part of a retiree's annuity when applying the filing requirements, see the discussion in Part II, Rules for Retirees, or Part III, Rules for Disability Retirement and Credit for the Elderly or the Disabled, whichever applies. To find the taxable part of each survivor annuity when applying the filing requirements, see the discussion in Part IV, Rules for Survivors of Federal Employees, or Part V, Rules for Survivors of Federal Retirees, whichever applies.

Part II Rules for Retirees

This part of the publication is for retirees who retired on nondisability retirement. If you retired on disability, see Part III, Rules for Disability Retirement and Credit for the Elderly or the Disabled, later.

Annuity statement. The statement you received from OPM when your CSRS or FERS annuity was approved shows the commencing date (the annuity starting date), the gross monthly rate of your annuity benefit, and your total contributions to the retirement plan (your cost). You will use this information to figure the tax-free recovery of your cost.

Annuity starting date. If you retire from federal government service on a regular annuity, your annuity starting date is the commencing date on your annuity statement from OPM. If something delays payment of your annuity, such as a late application for retirement, it does not affect the date your annuity begins to accrue or your annuity starting date.

Gross monthly rate. This is the amount you were to get after any adjustment for electing a survivor's annuity or for electing the lump-sum payment under the alternative annuity option (if either applied) but before any deduction for income tax withholding, insurance premiums, etc.

Your cost. Your monthly annuity payment contains an amount on which you have previously paid income tax. This amount represents part of your contributions to the retirement plan. Even though you did not receive the money that was contributed to the plan, it was included in your gross income for federal income tax purposes in the years it was taken out of your pay.

The cost of your annuity is the total of your contributions to the retirement plan, as shown on your annuity statement from OPM. If you elected the alternative annuity option, it includes any deemed deposits and any deemed redeposits that were added to your lump-sum credit. (See Lump-sum credit under Alternative Annuity Option, later.)

If you repaid contributions that you had withdrawn from the retirement plan earlier, or if you paid into the plan to receive full credit for service not subject to retirement deductions, the entire repayment, including any interest, is a part of your cost. You cannot claim an interest deduction for any interest payments. You cannot treat these payments as voluntary contributions; they are considered regular employee contributions.

Recovering your cost tax free. How you figure the tax-free recovery of the cost of your CSRS or FERS annuity depends on your annuity starting date.

If your annuity starting date is before July 2, 1986, either the Three-Year Rule or the General Rule (both discussed later) applies to your annuity.
If your annuity starting date is after July 1, 1986, and before November 19, 1996, you could have chosen to use either the General Rule or the Simplified Method (discussed later).
If your annuity starting date is after November 18, 1996, you must use the Simplified Method.

Under both the General Rule and the Simplified Method, each of your monthly annuity payments is made up of two parts: the tax-free part that is a return of your cost, and the taxable part that is the amount of each payment that is more than the part that represents your cost (unless such payment is used for purposes discussed under Distributions Used To Pay Insurance Premiums for Public Safety Officers, later). The tax-free part is a fixed dollar amount. It remains the same, even if your annuity is increased. Generally, this rule applies as long as you receive your annuity. However, see Exclusion limit, later.

Choosing a survivor annuity after retirement. If you retired without a survivor annuity and report your annuity under the Simplified Method, do not change your tax-free monthly amount even if you later choose a survivor annuity.

If you retired without a survivor annuity and report your annuity under the General Rule, you must figure the tax-free part of your annuity using a new exclusion percentage if you later choose a survivor annuity and take reduced annuity payments. To figure the new exclusion percentage, reduce your cost by the amount you previously recovered tax free. Figure the expected return as of the date the reduced annuity begins. For details on the General Rule, see Publication 939.

Canceling a survivor annuity after retirement. If you retired with a survivor annuity payable to your spouse upon your death and you notify OPM that your marriage has ended, your annuity might be increased to remove the reduction for a survivor benefit. The increased annuity does not change the cost recovery you figured at the annuity starting date. The tax-free part of each annuity payment remains the same.

For more information about choosing or canceling a survivor annuity after retirement, contact OPM's Retirement Information Office at 1-888-767-6738 (customers within the local Washington, D.C. calling area must call 202-606-0500).

Exclusion limit. Your annuity starting date determines the total amount of annuity payments that you can exclude from income over the years.

Annuity starting date after 1986. If your annuity starting date is after 1986, the total amount of annuity income that you (or the survivor annuitant) can exclude over the years as a return of your cost cannot exceed your total cost. Annuity payments you or your survivors receive after the total cost in the plan has been recovered are generally fully taxable.

Example.

Your annuity starting date is after 1986 and you exclude $100 a month under the Simplified Method. If your cost is $12,000, the exclusion ends after 10 years (120 months). Thereafter, your entire annuity is generally fully taxable.

Annuity starting date before 1987. If your annuity starting date is before 1987, you can continue to take your monthly exclusion figured under the General Rule or Simplified Method for as long as you receive your annuity. If you chose a joint and survivor annuity, your survivor can continue to take that same exclusion. The total exclusion may be more than your cost.

Deduction of unrecovered cost. If your annuity starting date is after July 1, 1986, and the cost of your annuity has not been fully recovered at your (or the survivor annuitant's) death, a deduction is allowed for the unrecovered cost. The deduction is claimed on your (or your survivor's) final tax return as a miscellaneous itemized deduction (not subject to the 2%-of-adjusted-gross-income limit). If your annuity starting date is before July 2, 1986, no tax benefit is allowed for any unrecovered cost at death.

Simplified Method

If your annuity starting date is after November 18, 1996, you must use the Simplified Method to figure the tax-free part of your CSRS or FERS annuity. (OPM has figured the taxable amount of your annuity shown on your Form CSA 1099R using the Simplified Method.) You could have chosen to use either the Simplified Method or the General Rule if your annuity starting date is after July 1, 1986, but before November 19, 1996. The Simplified Method does not apply if your annuity starting date is before July 2, 1986.

Under the Simplified Method, you figure the tax-free part of each full monthly payment by dividing your cost by a number of months based on your age. This number will differ depending on whether your annuity starting date is before November 19, 1996, or after November 18, 1996. If your annuity starting date is after 1997 and your annuity includes a survivor benefit for your spouse, this number is based on your combined ages.

Worksheet A. Use Worksheet A, Simplified Method (near the end of this publication), to figure your taxable annuity. Be sure to keep the completed worksheet. It will help you figure your taxable amounts for later years.

Instead of Worksheet A, you generally can use the Simplified Method Worksheet in the instructions for Form 1040, Form 1040A, or Form 1040NR to figure your taxable annuity. However, you must use Worksheet A and Worksheet B in this publication if you chose the alternative annuity option, discussed later.

Line 2. See Your cost, earlier, for an explanation of your cost in the plan. If your annuity starting date is after November 18, 1996, and you chose the alternative annuity option (explained later), you must reduce your cost by the tax-free part of the lump-sum payment you received.

Line 3. The number you enter on line 3 is the number of monthly annuity payments under the plan. Find the appropriate number from one of the tables at the bottom of the worksheet. If your annuity starting date is after 1997, use:

Table 1 for an annuity without a survivor benefit, or
Table 2 for an annuity with a survivor benefit.

If your annuity starting date is before 1998, use Table 1.

Line 6. If you retired before 2007, the amount previously recovered tax free that you must enter on line 6 is the total amount from line 10 of last year's worksheet. If your annuity starting date is before November 19, 1996, and you chose the alternative annuity option, this amount includes the tax-free part of the lump-sum payment you received.

Example.

Bill Smith retired from the Federal Government on March 31, 2007, under an annuity that will provide a survivor benefit for his wife, Kathy. His annuity starting date is April 1, 2007. He must use the Simplified Method to figure the tax-free part of his annuity benefits.

Bill's monthly annuity benefit is $1,000. He had contributed $31,000 to his retirement plan and had received no distributions before his annuity starting date. At his annuity starting date, he was 65 and Kathy was 57.

Bill's completed Worksheet A is shown on the next page. To complete line 3, he used Table 2 at the bottom of the worksheet and found that 310 is the number in the second column opposite the age range that includes 122 (his and Kathy's combined ages). Bill keeps a copy of the completed worksheet for his records. It will help him (and Kathy, if she survives him) figure the taxable amount of the annuity in later years.

Bill's tax-free monthly amount is $100. (See line 4 of the worksheet.) If he lives to collect more than 310 monthly payments, he will generally have to include in his gross income the full amount of any annuity payments received after 310 payments have been made.

If Bill does not live to collect 310 monthly payments and his wife begins to receive monthly payments, she also will exclude $100 from each monthly payment until 310 payments (Bill's and hers) have been collected. If she dies before 310 payments have been made, a miscellaneous itemized deduction (not subject to the 2%-of-adjusted- gross-income limit) will be allowed for the unrecovered cost on her final income tax return.

General Rule

If your annuity starting date is after November 18, 1996, you cannot use the General Rule to figure the tax-free part of your CSRS or FERS annuity. If your annuity starting date is after July 1, 1986, but before November 19, 1996, you could have chosen to use either the General Rule or the Simplified Method. If your annuity starting date is before July 2, 1986, you could have chosen to use the General Rule only if you could not use the Three-Year Rule.

Under the General Rule, you figure the tax-free part of each full monthly payment by multiplying the initial gross monthly rate of your annuity by an exclusion percentage. Figuring this percentage is complex and requires the use of actuarial tables. For these tables and other information about using the General Rule, see Publication 939.

Three-Year Rule

If your annuity starting date was before July 2, 1986, you probably had to report your annuity using the Three-Year Rule. Under this rule, you excluded all the annuity payments from income until you fully recovered your cost. After your cost was recovered, all payments became fully taxable. You cannot use another rule to again exclude amounts from income.

The Three-Year Rule was repealed for retirees whose annuity starting date is after July 1, 1986.

Worksheet A. Simplified Method for Bill Smith

See the instructions in Part II of this publication under Simplified Method.

1.	Enter the total pension or annuity payments received this year. Also, add this amount to the total for Form 1040, line 16a; Form 1040A, line 12a; or Form 1040NR, line 17a			1.	$ 8,000
2.	Enter your cost in the plan at the annuity starting date, plus any death benefit exclusion ^*			2.	31,000
	Note: If your annuity starting date was before this year and you completed this worksheet last year, skip line 3 and enter the amount from line 4 of last year's worksheet on line 4 below. Otherwise, go to line 3.
3.	Enter the appropriate number from Table 1 below. But if your annuity starting date was after 1997 and the payments are for your life and that of your beneficiary, enter the appropriate number from Table 2 below.			3.	310
4.	Divide line 2 by line 3			4.	100
5.	Multiply line 4 by the number of months for which this year's payments were made. If your annuity starting date was before 1987, skip lines 6 and 7 and enter this amount on line 8. Otherwise, go to line 6			5.	800
6.	Enter any amounts previously recovered tax free in years after 1986. This is the amount shown on line 10 of your worksheet for last year			6.	0
7.	Subtract line 6 from line 2			7.	31,000
8.	Enter the smaller of line 5 or line 7			8.	800
9.	Taxable amount for year. Subtract line 8 from line 1. Enter the result, but not less than zero. Also, add this amount to the total for Form 1040, line 16b, or Form 1040A, line 12b. If you are a nonresident alien, also enter this amount on line 1 of Worksheet C. If your Form CSA 1099R or Form CSF 1099R shows a larger amount, use the amount on this line instead. If you are a retired public safety officer, see Distributions Used To Pay Insurance Premiums for Public Safety Officers in Part II before entering an amount on your tax return or Worksheet C, line 1			9.	$7,200
10.	Was your annuity starting date before 1987? Yes. Do not complete the rest of this worksheet. No. Add lines 6 and 8. This is the amount you have recovered tax free through 2007. You will need this number if you need to fill out this worksheet next year			10.	800
11.	Balance of cost to be recovered. Subtract line 10 from line 2. If zero, you will not have to complete this worksheet next year. The payments you receive next year will generally be fully taxable			11.	$30,200
Table 1 for Line 3 Above
	IF your age on your annuity starting date was	AND your annuity starting date was—
	IF your age on your annuity starting date was	before November 19, 1996, THEN enter on line 3	after November 18, 1996, THEN enter on line 3
	55 or under	300	360
	56-60	260	310
	61-65	240	260
	66-70	170	210
	71 or over	120	160
Table 2 for Line 3 Above
	IF the annuitants' combined ages on your annuity starting date were	THEN enter on line 3
	110 or under	410
	111-120	360
	121-130	310
	131-140	260
	141 or over	210

* A death benefit exclusion of up to $5,000 applied to certain benefits received by survivors of employees who died before August 21, 1996.

Alternative Annuity Option

If you are eligible, you may choose an alternative form of annuity. If you make this choice, you will receive a lump-sum payment equal to your contributions to the plan and a reduced monthly annuity. You are eligible to make this choice if you meet all of the following requirements.

You are retiring, but not on disability.
You have a life-threatening illness or other critical medical condition.
You do not have a former spouse entitled to court ordered benefits based on your service.

If you are not eligible or do not choose this alternative annuity, you can skip the following discussion and go to Federal Gift Tax, later.

Lump-Sum Payment

The lump-sum payment you receive under the alternative annuity option generally has a tax-free part and a taxable part. The tax-free part represents part of your cost. The taxable part represents part of the earnings on your annuity contract. Your lump-sum credit (discussed later) may include a deemed deposit or redeposit that is treated as being included in your lump-sum payment even though you do not actually receive such amounts. Deemed deposits and redeposits, which are described later under Lump-sum credit, are taxable to you in the year of retirement. Your taxable amount may therefore be more than the lump-sum payment you receive.

You must include the taxable part of the lump-sum payment in your income for the year you receive the payment unless you roll it over into another qualified plan or a traditional IRA. If you do not have OPM transfer the taxable amount to an IRA or other plan in a direct rollover, tax will be withheld at a 20% rate. See Rollover Rules, later, for information on how to make a rollover.

OPM can make a direct rollover only up to the amount of the lump-sum payment. Therefore, to defer tax on the full taxable amount if it is more than the payment, you must add funds from another source.

The taxable part of the lump-sum payment does not qualify as a lump-sum distribution eligible for capital gain treatment or the 10-year tax option. It also may be subject to an additional 10% tax on early distributions if you separate from service before the calendar year in which you reach age 55, even if you reach age 55 in the year you receive the lump-sum payment. For more information, see Lump-Sum Distributions and Tax on Early Distributions in Publication 575.

Worksheet B. Use Worksheet B, Lump-Sum Payment (near the end of this publication), to figure the taxable part of your lump-sum payment. Be sure to keep the completed worksheet for your records.

To complete the worksheet, you will need to know the amount of your lump-sum credit and the present value of your annuity contract.

Lump-sum credit. Generally, this is the same amount as the lump-sum payment you receive (the total of your contributions to the retirement system). However, for purposes of the alternative annuity option, your lump-sum credit also may include deemed deposits and redeposits that OPM advanced to your retirement account so that you are given credit for the service they represent. Deemed deposits (including interest) are for federal employment during which no retirement contributions were taken out of your pay. Deemed redeposits (including interest) are for any refunds of retirement contributions that you received and did not repay. You are treated as if you had received a lump-sum payment equal to the amount of your lump-sum credit and then had made a repayment to OPM of the advanced amounts.

Present value of your annuity contract. The present value of your annuity contract is figured using actuarial tables provided by the IRS.

If you are receiving a lump-sum payment under the Alternative Annuity Option, you can write to the address below to find out the present value of your annuity contract.

Internal Revenue Service
Actuarial Group 2 SE:T:EP:RA:T:A2
1111 Constitution Ave., NW PE-4G6
Washington, DC 20224

Example.

David Brown retired from the federal government in 2007, one month after his 55th birthday. He had contributed $31,000 to his retirement plan and chose to receive a lump-sum payment of that amount under the alternative annuity option. The present value of his annuity contract was $155,000.

The tax-free part and the taxable part of the lump-sum payment are figured using Worksheet B, as shown on the next page. The taxable part ($24,800) is also his net cost in the plan, which is used to figure the taxable part of his reduced annuity payments. See Reduced Annuity, later.

Worksheet B. Lump-Sum Payment for David Brown See the instructions in Part II of this publication under Alternative Annuity Option.

1.	Enter your lump-sum credit (your cost in the plan at the annuity starting date)	1.	$ 31,000
2.	Enter the present value of your annuity contract	2.	155,000
3.	Divide line 1 by line 2	3.	.20
4.	Tax-free amount. Multiply line 1 by line 3. (Caution: Do not include this amount on line 6 of Worksheet A in this publication.)	4.	$6,200
5.	Taxable amount (net cost in the plan). Subtract line 4 from line 1. Include this amount in the total on Form 1040, line 16b; Form 1040A, line 12b; or Form 1040NR, line 17b. Also, enter this amount on line 2 of Worksheet A in this publication.	5.	$24,800

Lump-sum payment in installments. If you choose the alternative annuity option, you usually will receive the lump-sum payment in two equal installments. You will receive the first installment after you make the choice upon retirement. The second installment will be paid to you, with interest, in the next calendar year. (Exceptions to the installment rule are provided for cases of critical medical need.)

Even though the lump-sum payment is made in installments, the overall tax treatment (explained at the beginning of this discussion) is the same as if the whole payment were paid at once. If the payment has a tax-free part, you must treat the taxable part as received first.

How to report. Add any actual or deemed payment of your lump-sum credit (defined earlier) to the total for Form 1040, line 16a; Form 1040A, line 12a; or Form 1040NR, line 17a. Add the taxable part to the total for Form 1040, line 16b; Form 1040A, line 12b; or Form 1040NR, line 17b, unless you roll over the taxable part to your traditional IRA or a qualified retirement plan.

If you receive the lump-sum payment in two installments, include any interest paid with the second installment on line 8a of either Form 1040 or Form 1040A , or on line 9a of Form 1040NR.

Reduced Annuity

If you have chosen to receive a lump-sum payment under the alternative annuity option, you also will receive reduced monthly annuity payments. These annuity payments each will have a tax-free and a taxable part. To figure the tax-free part of each annuity payment, you must use the Simplified Method (Worksheet A). For instructions on how to complete the worksheet, see Worksheet A under Simplified Method, earlier.

To complete Worksheet A, line 2, you must reduce your cost in the plan by the tax-free part of the lump-sum payment you received. Enter as your net cost on line 2 the amount from Worksheet B, line 5. Do not include the tax-free part of the lump-sum payment with other amounts recovered tax free (Worksheet A, line 6) when limiting your total exclusion to your total cost.

Example.

The facts are the same as in the example for David Brown in the preceding discussion. In addition, David received 10 annuity payments in 2007 of $1,200 each. Using Worksheet A, he figures the taxable part of his annuity payments. He completes line 2 by reducing his $31,000 cost by the $6,200 tax-free part of his lump-sum payment. His entry on line 2 is his $24,800 net cost in the plan (the amount from Worksheet B, line 5). He does not include the tax-free part of his lump-sum payment on Worksheet A, line 6. David's filled-in Worksheet A is shown on the next page.

Worksheet A. Simplified Method for David Brown

See the instructions in Part II of this publication under Simplified Method.

1.	Enter the total pension or annuity payments received this year. Also, add this amount to the total for Form 1040, line 16a; Form 1040A, line 12a; or Form 1040NR, line 17a		1.	$ 12,000
2.	Enter your cost in the plan at the annuity starting date, plus any death benefit exclusion ^*		2.	24,800
	Note: If your annuity starting date was before this year and you completed this worksheet last year, skip line 3 and enter the amount from line 4 of last year's worksheet on line 4 below. Otherwise, go to line 3.
3.	Enter the appropriate number from Table 1 below. But if your annuity starting date was after 1997 and the payments are for your life and that of your beneficiary, enter the appropriate number from Table 2 below.		3.	360
4.	Divide line 2 by line 3		4.	68.89
5.	Multiply line 4 by the number of months for which this year's payments were made. If your annuity starting date was before 1987, skip lines 6 and 7 and enter this amount on line 8. Otherwise, go to line 6		5.	688.90
6.	Enter any amounts previously recovered tax free in years after 1986. This is the amount shown on line 10 of your worksheet for last year		6.	0
7.	Subtract line 6 from line 2		7.	24,800
8.	Enter the smaller of line 5 or line 7		8.	688.90
9.	Taxable amount for year. Subtract line 8 from line 1. Enter the result, but not less than zero. Also, add this amount to the total for Form 1040, line 16b, or Form 1040A, line 12b. If you are a nonresident alien, also enter this amount on line 1 of Worksheet C. If your Form CSA 1099R or Form CSF 1099R shows a larger amount, use the amount on this line instead. If you are a retired public safety officer, see Distributions Used To Pay Insurance Premiums for Public Safety Officers in Part II before entering an amount on your tax return or Worksheet C, line 1		9.	$11,311.10
10.	Was your annuity starting date before 1987? Yes. Do not complete the rest of this worksheet. No. Add lines 6 and 8. This is the amount you have recovered tax free through 2007. You will need this number if you need to fill out this worksheet next year		10.	688.90
11.	Balance of cost to be recovered. Subtract line 10 from line 2. If zero, you will not have to complete this worksheet next year. The payments you receive next year will generally be fully taxable		11.	$24,111.10
Table 1 for Line 3 Above
	IF your age on your annuity starting date was	AND your annuity starting date was—
	IF your age on your annuity starting date was