Exclusion Ratio
The exclusion ratio determines what portion of each annuity payment is tax-free (return of principal) versus taxable (earnings), calculated by dividing the investment in the contract by expected return.
Get personalized explanations
š¬ Video Explanation
š”
Exam Tip
Exclusion ratio = Investment / Expected Return. Applies only to non-qualified annuities. After basis recovered, 100% taxable.
What is the Exclusion Ratio?
When you receive payments from an annuity purchased with after-tax dollars, part of each payment is tax-free (your original investment being returned) and part is taxable (earnings).
The Formula
Exclusion Ratio = Investment in Contract / Expected Return
Example
| Item | Amount |
|---|---|
| Investment | $100,000 |
| Expected Return | $200,000 (over lifetime) |
| Exclusion Ratio | 50% |
Each $1,000 payment:
- $500 tax-free (return of basis)
- $500 taxable (earnings)
Key Points
| Situation | Tax Treatment |
|---|---|
| Before basis recovered | Exclusion ratio applies |
| After basis recovered | 100% taxable |
| Death before recovering basis | Deduction for unrecovered amount |
| Qualified annuity | Exclusion ratio doesn't apply (all taxable) |
Qualified vs. Non-Qualified
| Type | Exclusion Ratio? | Tax Treatment |
|---|---|---|
| Qualified (IRA, 401k) | No | All payments taxable |
| Non-Qualified | Yes | Part tax-free, part taxable |
Study This Term In
Related Terms
Learn More with AI
10 free AI interactions per day
Stay Updated
Get free exam tips and study guides delivered to your inbox.