Washington Life Producer Practice Exam

Which method is used to calculate the taxable portion of annuity payments?

1. Tax Ratio

2. Exclusion Ratio

3. Capitalization Ratio

4. Investment Ratio

The correct answer is: Exclusion Ratio

The Exclusion Ratio is the method used to determine the taxable portion of annuity payments. This ratio represents the portion of each annuity payment that is considered a return of the original investment, which is not subject to taxation. The Exclusion Ratio is calculated by taking the investment in the contract (the amount paid into the annuity) and dividing it by the total expected return (the total amount expected to be received from the annuity during its life). For instance, if an individual invests $100,000 in an annuity that is expected to pay out $300,000 over time, the Exclusion Ratio would be calculated to identify how much of each payment is considered a return of the initial investment, and thus not taxable. The remaining portion of the payment is then treated as ordinary income and subject to taxation. This method is critical for taxpayers to determine how much of their annuity payments are taxable, helping them plan their tax obligations more accurately throughout the years they receive those payments.