Question 1

What is an annuity exclusion ratio?

Accepted Answer

The exclusion ratio determines what fraction of each annuity payment is a tax-free return of your original investment versus taxable income. It equals your premium divided by your expected total return. If you paid $250,000 for an annuity that will pay out $413,000 over 20 years, your exclusion ratio is about 60.5%. That means 60.5% of each monthly payment is tax-free, and 39.5% is ordinary taxable income.

Question 2

How are annuity payments taxed?

Accepted Answer

For a non-qualified annuity purchased with after-tax dollars, each payment is partly a tax-free return of basis and partly ordinary income. The taxable portion equals the payment amount multiplied by (1 minus the exclusion ratio). That taxable portion is taxed at your ordinary income rate, not the lower capital gains rate.

Question 3

What is the difference between a fixed and variable annuity?

Accepted Answer

A fixed annuity pays a guaranteed interest rate set by the insurance company, producing predictable monthly income. A variable annuity ties returns to a portfolio of sub-accounts (similar to mutual funds), so payments can rise or fall with market performance. Fixed annuities carry lower risk. Variable annuities have higher growth potential but no income guarantee without an optional rider.

Question 4

When does an annuity make sense versus a self-managed portfolio?

Accepted Answer

Annuities make sense when you need guaranteed lifetime income and want to eliminate the risk of outliving your savings. A self-managed portfolio using the 4% rule gives more flexibility and potentially higher returns but exposes you to sequence-of-returns risk. Annuities also offer less liquidity. The calculator compares your annuity net monthly income against a rough self-managed withdrawal so you can see the trade-off directly.

Question 5

What happens if you die before the annuity payout period ends?

Accepted Answer

This depends on the annuity contract. A period-certain annuity guarantees payments for the full term (e.g., 20 years) regardless. If you die early, your beneficiary continues receiving payments for the remaining years. A life-only annuity pays until death and stops there, with no payments to heirs. A joint and survivor annuity continues payments to a surviving spouse. Always check the contract type before purchasing.

Premium	Monthly Payment	Exclusion Ratio	After-Tax Monthly
$150K, 20 yrs, 5%	$989/mo	60.4%	$854/mo
$250K, 20 yrs, 5%	$1,649/mo	60.4%	$1,423/mo
$500K, 25 yrs, 5%	$2,924/mo	54.8%	$2,453/mo

Premium	Monthly Payment	Exclusion Ratio	After-Tax Monthly
$150K, 20 yrs, 5%	$989/mo	60.4%	$854/mo
$250K, 20 yrs, 5%	$1,649/mo	60.4%	$1,423/mo
$500K, 25 yrs, 5%	$2,924/mo	54.8%	$2,453/mo

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