Exclusion Ratio

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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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Other companies do it a different way, letting investors into their annuity with no benefits during accumulation, and then adding riders later, which also use SPIA-like exclusion ratios.
At some point, of course, the taxman must be paid; when the exclusion ratio has captured all of the cost basis, it ends and all remaining income is taxed.
On top of that, the $375,000 donation will yield $519,000 of income to the donor over their lifetime, and because of exclusion ratios contained in nonqualified annuities, the income tax due on the annuity income will be reduced further until the cost basis of $375,000 has been paid out.
The pre-July 1986 investment in the contract and the post-June 1986 investment in the contract are adjusted for the purpose of determining the exclusion ratios in the following manner:
Only dividends that were excludable from gross income are subtracted from gross premiums to determine the net premium cost used in determining the investment in the contract for purposes of the exclusion ratio.
An exclusion ratio (which may be expressed as a fraction or as a percentage) must be determined for the contract.
The exclusion ratio of an individual whose annuity starting date (see Q 10) is after December 31, 1986, applies to payments received until the payment in which the investment in the contract is fully recovered.
The usual annuity treatment, involving exclusion ratios, results in part of the "basic" $5,000 benefit being taxable, as a result of interest earned.
The table below presents exclusion ratios for various interest rates and payout periods.
FIXED-PERIOD ANNUITY EXCLUSION RATIOS Years in Payout Period Interest 10 20 30 40 1% 94.
Once again, based on values in the exclusion ratio table, the annuitant would treat 53% of any payment in excess of $52,872 as a tax-free recovery of investment.
This liquidity comes at a price, however, in that exclusion ratios do not apply to such partial withdrawals under the federal income tax code.