What is the Exclusion Ratio on a SPIA?

The Annuity Man

Annuities were first introduced in the Roman Times as a lifetime income payment for the dutiful Roman soldiers and their families.  The Latin word "annua" means payment, and is the origin of the word "annuity."  In fact, that first Roman annuity is today's Single Premium Immediate Annuity (SPIA).  SPIAs are also referred to as "immediate annuities," "pension annuities," and "retirement annuities."

All annuity income, regardless of type, is a combination of return of principal plus interest.  Regardless of what type of account a SPIA is in, the contractual guarantees are the same.  It doesn't matter if the account type is a Traditional IRA, Roth IRA, or non-IRA.  The numbers are the same, the only difference is how the income stream is taxed.

The exclusion ratio is addressing the part of the income stream that is not taxable in a non-IRA account.  Because SPIA income is always a combination of return of principal plus interest, in a non-qualified (i.e. non-IRA) account...only the interest portion of that payment is taxable.  That ratio remains that way until the account goes to $0 in value, and at that time...100% of the income becomes taxable.

SPIA income from a Traditional IRA is fully taxable at ordinary income levels, and SPIA income from a Roth IRA is fully tax-free.  Exclusion Ratio SPIA income is tax preferential when using a non-IRA (i.e. non-qualified) account.

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