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Jay, a single taxpayer, retired from his job as a public school teacher in 2012. He is to receive a retirement annuity of $1,200 each month and his life expectancy is 180 months. He contributed $36,000 to the pension plan during his 35-year career; so his adjusted basis is $36,000. Jay collected 192 payments before he died. What is the correct method for reporting the pension income?

Since Jay is no longer working, none of the pension payments must be included in his gross income.

The first $36,000 received is a nontaxable recovery of capital, and all subsequent annuity payments are taxable.

The first $180,000 he receives is taxable and the last $36,000 is a nontaxable recovery of capital.

All of the last 12 payments he received ($14,400) are taxable.

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