Life · Chapter 9 · Annuity Taxation
Exclusion Ratio
Definition
Determines the tax-free portion of each annuity payment: investment in the contract ÷ expected return. The return-of-principal portion is tax-free; the growth portion is taxed as ordinary income.
Example
$120,000 invested; $6,000/yr expected for 25 years → expected return $150,000. Ratio = 120/150 = 80% → $4,800 of each $6,000 payment is tax-free, $1,200 is taxable.
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