Not every dollar of a non-qualified annuity payment is taxable — a portion is simply the investor’s own money coming back, until the original cost is fully recovered.
How it works
The exclusion ratio is the investment in the contract divided by the total expected return (the payment amount times the number of expected payments from an IRS life expectancy table). That ratio applies to every payment until the cost basis is fully recovered, splitting each payment into a tax-free and a taxable portion.
What this does not include
Once the investor’s full cost basis has been recovered through the tax-free portions of prior payments, every subsequent payment becomes fully taxable — this calculator computes the ratio for the recovery period, not the point where recovery is complete.
How to use this calculator
- Enter the investment in the contract, the monthly payment amount, and the life expectancy multiple from IRS Table V.
Frequently asked questions
Does this apply to a qualified annuity inside an IRA?
No — annuities held inside a traditional IRA are already fully taxable on withdrawal (since contributions were pre-tax); the exclusion ratio applies specifically to non-qualified annuities purchased with after-tax dollars.
What happens after the cost basis is fully recovered?
Every subsequent payment becomes 100% taxable — the exclusion ratio only applies during the recovery period, not for the life of the annuity.
Why does IRS Publication 939 use a life expectancy table?
Because a life annuity’s total number of payments isn’t known in advance — the table provides an actuarially expected number of payments to compute total expected return.
