The exclusion ratio is defined as the percentage of what?

• A. Interest in the contract
• B. Contribution basis to total
• C. Death benefit
• D. Investment in subaccounts

Answer: (B)

The exclusion ratio shows how much of each annuity payment is a return of the investor’s principal and thus not taxed. It’s calculated by dividing the investment in the contract (the investor’s basis) by the expected total return (the total amount the contract is expected to pay out). Expressed as a percentage, it represents the portion of the payment that is a return of the contributed amount, i.e., the contribution basis to the total payout. The other ideas—the contract’s interest rate, a death benefit, or amounts invested in subaccounts—don’t define how the nontaxable portion of each payment is determined.