The exclusion ratio equals the annuity's cost basis divided by what?

The exclusion ratio equals the annuity's cost basis divided by what?

• A. Annuity's cost basis/Total expected return
• B. Total expected return/Annuity's cost basis
• C. Cost basis plus total expected return
• D. Annuity's cost basis minus total expected return

Answer: (A)

The exclusion ratio shows what part of each annuity payment is a tax-free return of principal. It’s found by dividing the amount you invested (the cost basis) by the total amount the contract is expected to pay out over its life (the total expected return). That fraction tells you the portion of each payment that is not taxable, with the rest being taxable as ordinary income. For example, if the cost basis is 50,000 and the total expected return is 200,000, the exclusion ratio is 0.25, so 25% of every payment is tax-free and 75% is taxable. The other options don’t compute this proportion correctly: they either invert the ratio or combine the figures in a way that doesn’t reflect the portion of principal returned tax-free.

The exclusion ratio shows what part of each annuity payment is a tax-free return of principal. It’s found by dividing the amount you invested (the cost basis) by the total amount the contract is expected to pay out over its life (the total expected return). That fraction tells you the portion of each payment that is not taxable, with the rest being taxable as ordinary income. For example, if the cost basis is 50,000 and the total expected return is 200,000, the exclusion ratio is 0.25, so 25% of every payment is tax-free and 75% is taxable. The other options don’t compute this proportion correctly: they either invert the ratio or combine the figures in a way that doesn’t reflect the portion of principal returned tax-free.