Exclusion ratio

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Exclusion ratio
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Exclusion ratio is determined by dividing the investment included in the contract by the return that is expected from the contract as of commencement date of the annuity, and rounding to the tenth. Once calculated, the exclusion ratio applies to each pension payment given under the contract. The procedure processes up to the time when the total investment has been recovered tax-free (T. M. Myres, D. D. DeScherer 2008, P. 85). The exclusion ratio generally is not redetermined, unless a new type of annuity becomes salaried (W. D. Mitchell 2008, P. 116). After determining the ratio it remains constant, any additional payments are to be fully taxable (O. R. Whittington, P. R. Delaney 2011, Module 35).

The formula to calculate exclusion ratio (T. M. Myres, D. D. DeScherer 2008P. 85):

\(ER = \frac{I}{R}\)


  • ER - exclusion ratio
  • I - investment in a contract
  • R - expected return

In case there was no investment mentioned in the contract, all payments are taxable in full (T. M. Myres, D. D. DeScherer 2008, P. 85). Exclusion ratio determines taxable and non taxable components of payments taxable under Code Section 72 (W. D. Mitchell 2008, P. 115). The annuity exclusion ratio is used to determine the amount of each payment that is being excluded from income. It is the cost of the contract divided by the number of payments expected (K. E. Murphy, M. Higgins, T. K. Flesher, R. K. Skalberg 2017, P. 3-11).

Determining exclusion ratio

Before determining exclusion ratio, following steps must be performed (W. D. Mitchell 2008, P. 115):

  1. Determining whether the amount is paid after the annuity starting date (the date of the first day of the first period for which an amount is payable).
  2. Determining whether the amount is received as an annuity. It is received as an annuity given that it is payable at regular intervals over more than one-year period.


Author: Karolina Liskiewicz