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Regarding payments from an immediate annuity or annuitization, part of each payment the annuitant receives is considered to be a return of principal, which is not taxed. The remaining portion of the payment consists of interest earnings and is taxable. The exclusion ratio determines the taxable and nontaxable portions of each payment. The formula is:

Investment in the Contract
Expected Return

The exclusion ratio runs out when all of the principal in the contract has been received (assuming you reach that point in the contract). When the entire amount of principal has been exhausted, the entire annuity payment will then be taxable.

Last Updated: 9/23/2012 10:05:00 PM