Exclusion Ratio

Exclusion Ratio

The percentage of an investor's return that is not subject to taxes. The exclusion ratio is a percentage with a dollar amount equal to the payback on one's initial investment. Any return above the exclusion ratio is subject to taxes. Most of the time, the exclusion ratio applies to non-qualified annuities.
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The "exclusion ratio" is $100,000 over $120,000 (investment/assumed return), or 5/6.
To compute the annuity exclusion ratio, expected return is found by multiplying one year's annuity payments by a multiple from the appropriate IRS annuity table.
Also, because this is annuitization, the beneficiary has the benefit of the exclusion ratio treatment on distributions, with each payment being partially a tax-free return of principal and taxable interest.
In computing the exclusion ratio for the payments, the amount to be used as the investment in the contract is premium cost, not the maturity value.
In certain trading annuities, when income is to be turned on, there is a SPIA-like withdrawal benefit that offers an exclusion ratio. This means that for a person who decides to begin income after 10 years--let's say at age 65 or so--the income is going to be largely untaxed for a number of years; perhaps 70 percent or more won't be taxed over a fairly long period of time.
Because the court in Wandry allowed a company to transfer business interests based upon the value of the then-applicable gift tax exclusion amount, instead of specifying that each of his children will receive a certain percentage of the business in each of ten years, Kevin can create a gift transfer document that transfers a portion of the business that equals the annual exclusion ratio for each year.
72, amounts distributed are divided into taxable and nontaxable portions using an exclusion ratio. The exclusion ratio is determined by dividing the amount the employee previously included in income (i.e., the investment in the contract or basis) by the total amount of the expected payout of the trust interest (i.e., the expected return).
The rationale for the increase to 85% was based on an established principle of annuity taxation called the exclusion ratio. This ratio is the relationship of total (after-tax) payments made by the annuitant to the total expected payout over the life of the annuity.
In the case of Option No.1, the joint lifetime income annuity with a deposit of $156,796 provides the $10,000 annual income payment need with a 63.7 percent tax exclusion ratio. The exclusion ratio means that only 36.3 percent of each income payment is taxable, while 68.7 percent of the payment represents a pro-rata return of the principal basis.
Expected Return Multiples Gender Based Table I Ordinary Life Annuities One Life Table II Ordinary Joint Life and Two Lives Last Survivor Annuities Table IIA Annuities for Joint Two Lives Unisex Life Only Table V Ordinary Life Annuities One Life Table VI Ordinary Joint Life and Two Lives Last Survivor Annuities Table VIA Annuities for Joint Two Lives Life Only Percent Value of Refund Feature Table III Gender Based Table VII Unisex These tables can be found in Appendix A of Tax Facts on Insurance & Employee Benefits, published annually by The National Underwriter Company (2) Exclusion Ratio With Fixed Return.
Thus, the tax advantages of annuities (tax-deferral during accumulation, exclusion ratio applied to withdrawals, tax-free exchanges, no required distributions if nonqualified) may take on greater appeal going forward.
An exclusion ratio (which may be expressed as a fraction or as a percentage) must be determined for the contract.