Exclusion ratio

The exclusion ratio is used for taxing non-qualified immediate annuity payments or non – qualified deferred annuities which are distributed as instalments. It is a part of the sum that is not reported as ordinary income.

It is designed in the manner to return the owner – purchase annuity investment in tax-free amounts over the given period and to tax the balance of the sum received.

If a person purchases it for $100K at the age of 65, then the insurance firm can estimate the life expectancy to be 20 years and promise to give $565 a month for the rest of the life where they spread the total over 20 years and then get approx. monthly sum that is $417 a month) but it is higher than the calculated spread because the firm returns sum portion derived after tax plus interest.

The expected return and investment in contract are the terms used to calculate the portion of each annuity imbursement that is excluded from earnings as tax free of principal.

The exclusion ratio is considered to be part of the original investment instead of ordinary income earned on the money. The part of the each annuity expense eliminated from the earnings reduces the unrecovered investment.

Each disbursement is the non-taxable return of cost and part of the taxable revenue. Any additional interest associated with it is reported as the wage of the financial year and it should be determined as a part of the contract, while, the balance of guaranteed annuity payment is includable in gross proceeds for the given year received.

It is related to certain capital guarantee contracts and works as the ratio where the total investment bears to the total expected return. If the initial sum is greater than or equals the value of the likely returns, the full amount of each disbursement is received tax-free. If the owner – purchase is still alive at life expectancy, future payments are considered taxable.