How to Figure the Taxable Portion of Annuities

Shawn Plummer

CEO, The Annuity Expert

Figuring out the taxable portion of an annuity can be tricky. This guide will walk you through the process step-by-step, so you can understand how to calculate it correctly. Annuities can be a great way to save for retirement, but it is important to understand how much of your annuity is taxable, so you don’t end up paying too much in taxes. Let’s get started!

How to Calculate the Taxable Portion of Annuities

Annuities enable people to save money for the future while also allowing tax-deferred appreciation. The IRS expects to receive a share of the taxable portion when an annuity owner accepts a lifetime stream of payments. Annuities, unless they are set up as a qualified pre-tax plan such as an IRA, are financed with regular income. Because annuity owners already paid taxes on the money they put into their annuities, only the growth is taxable gain.

  1. Determine Cost Basis
  2. Divide Cost Basis By Accumulation Value
  3. Multiply Monthly Payout By Exclusion Ratio
  4. Subtract Tax-Free Portion

Step 1: Determine Cost Basis

Determine your cost basis. Find the sum of all deposits you made into the annuity. For example, if you deposited $500 a year for five years, your cost basis in the annuity is $2,500.

Step 2: Divide Cost Basis By Accumulation Value

Divide your cost basis by the accumulation value. The result is your exclusion ratio. For example, if you deposited $2,500 into an annuity and its accumulation value is $5,000, then your exclusion ratio is 50 percent.

Step 3: Multiply Monthly Payout By Exclusion Ratio

Multiply the size of your monthly payout by the exclusion ratio. The product is the portion of your payout that is excluded from taxation. For example, if your exclusion ratio is 50 percent and your monthly payments are $500, then $250 is excluded from taxation as a return of investment.

Step 4: Subtract Tax-Free Portion

Subtract the excluded portion from the total monthly payout to determine the taxable portion. For example, if the excluded portion of your $500 payment is $250, then your taxable portion is $150.

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Shawn Plummer

CEO, The Annuity Expert

I’m a licensed financial professional focusing on annuities and insurance for more than a decade. My former role was training financial advisors, including for a Fortune Global 500 insurance company. I’ve been featured in Time Magazine, Yahoo! Finance, MSN, SmartAsset, Entrepreneur, Bloomberg, The Simple Dollar, U.S. News and World Report, and Women’s Health Magazine.

The Annuity Expert is an online insurance agency servicing consumers across the United States. My goal is to help you take the guesswork out of retirement planning or find the best insurance coverage at the cheapest rates for you. 

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