Your cost in a pension or annuity plan is referred to as your net investment in the contract as of the annuity starting date. This is the first day of the first period for which you receive a benefit payment, or the date on which the obligations under the plan become fixed, whichever date is later. For example, once you have completed all the payments you are required to make to an annuity contract, and the plan benefits are scheduled to begin on February 1st of the year, for the period beginning January 1st, your annuity stating date is January 1st, since this is the first period for which annuity payments are made, even though you do no actually receive the benefits until February 1st. For tax purposes, you would need to determine your cost as of January 1st in this example.
Your annuity starting date will also determine which method you must use, as follows:
Annuity starting date after July 1, 1986, but before November 19, 1996 under a qualified plan: You could have chosen to use either the Simplified Method or the General Rule.
Annuity starting date on July 1, 1986 or before: You use the General Rule, unless you chose to use the Three-Year Rule. That rule was repealed for annuities starting after July 1, 1986, so if you used the Three-Year Rule, your annuity payments would now be fully taxable.
Annuity stating date on November 19, 1996 or later: You must use the Simplified Method if you meet both the following conditions:
You receive your payments from a qualified employee plan, a qualified employee annuity, or a tax-sheltered annuity plan (403(b) plan), and
On the annuity starting date, you are under 75 years of age, or you are entitled to less than 5 years of guaranteed payments. Otherwise, you must use the General Rule.