An annuity exclusion ratio is the percentage of an annuity’s payments that are not taxable. This may seem like a confusing concept, but it is actually quite simple to understand. In this guide, we will discuss what an annuity exclusion ratio is and how to use it in order to minimize your tax liability.
What Is The Exclusion Ratio?
The exclusion ratio is the method used to determine the taxable portion of each annuity payment. An annuity exclusion ratio is important to know because it can help you reduce your tax liability. If you are in a high tax bracket, you may want to consider investing in an annuity that has a high exclusion ratio. This way, you can receive more of your payments tax-free.
How Does The Exclusion Ratio Work?
The exclusion ratio concept is at the heart of the tax benefit of annuitizing a nonqualified annuity. To produce a percentage, income tax on periodic payments is measured against the anticipated return under the contract. The percentage is then multiplied by the periodic payments received under the settlement option to determine how much of the money received is tax-free as a return of the investment in the contract. The balance of each periodic payment is taxed as ordinary income.
- Investment Amount ÷ Expected Return = Percentage Of Payment That Is Tax-Free
- 100% – Tax-Free Percentage = Percentage Of Payment That Is Taxable
Exclusion Ratio Example
- $100,000 investment ÷ $150,000 expected return = .6666 (66.7 percent of payment is tax-free)
- 100% – 66.7% (tax-free percentage) = 33.3 percent of payment is taxable
Now that you know what an annuity exclusion ratio is and how it can help you, be sure to use this information to your advantage! By investing in an annuity with a high exclusion ratio, you can keep more of your money out of the hands of the IRS. Contact us today about whether an annuity is right for you.
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Frequently Asked Questions
What does the exclusion ratio determine?
The exclusion ratio determines how much of your annuity payments are taxable.