Tax Facts

538 / How is the excludable portion of payments calculated under an annuity with a single life refund or period-certain guarantee?

The computation outlined in Q 537 is for a straight life annuity (without a refund or period-certain guarantee). The exclusion ratio for a single life refund or period-certain guarantee is determined in the same way, but the investment in the contract first must be adjusted by subtracting the value of the refund or period-certain guarantee. The value of the refund or period-certain guarantee is computed by the following steps:

(1)     Determine the duration of the guaranteed amount (number of years necessary for the total guaranteed return to be fully paid). In the case of a period-certain life annuity, the duration of the guaranteed amount, in years, is known (e.g., 10, 15, or 20 “years certain”). To find the duration of the guaranteed amount, in years, for a cash or installment refund life annuity, divide the total guaranteed amount by the amount of one year’s annuity payments, and round the quotient to the nearest whole number of years.

(2)     Find the factor in Table III or VII (whichever is applicable, depending on when the investment is made in the contract) under the whole number of years (as determined above) and the age and (if applicable) the sex of the annuitant. This Table III or Table VII factor is the percentage value of the refund or period-certain guarantee.

(3)     Apply the applicable Table III or Table VII percentage to the smaller of (a) the investment in the contract, or (b) the total guaranteed return under the contract. The result is the present value of the refund or period-certain guarantee.

(4)     Subtract the present value of the refund or period-certain guarantee from the investment in the contract. The remainder is the adjusted investment in the contract to be used in the exclusion ratio.1

Example 3: On January 1, 2025, a husband, age 65, purchases for $21,053 an immediate installment refund annuity that pays $100 a month for life. The contract provides that in the event the husband does not live long enough to recover the full purchase price, payments will be made to his spouse until the total payments under the contract equal the purchase price. The investment in the contract is adjusted for the purpose of determining the exclusion ratio as follows:
































Unadjusted investment in the contract $21,053
Amount to be received annually $1,200
Duration of guaranteed amount ($21,053 ÷ $1,200) 17.5 yrs.
Rounded to nearest whole number of years 18
Percentage value of guaranteed refund (Table VII for age 65 and 18 years) 15%
Value of refund feature rounded to nearest dollar (15% of $21,053) $3,158
Adjusted investment in the contract ($21,053 – $3,158) $17,895

Example 4: Assume the contract in Example 3 was purchased as a deferred annuity, the pre-July 1986 investment in the contract is $10,000, and the post-June 1986 investment in the contract is $11,053. If the annuitant elects to compute a separate exclusion percentage for the pre-July 1986 and the post-June 1986 amounts, separate computations must be performed to determine the adjusted investment in the contract. The pre-July 1986 investment in the contract and the post-June 1986 investment in the contract are adjusted for the purpose of determining the exclusion ratios in the following manner:




































































































Pre-July 1986 adjustment:
Unadjusted investment in the contract $10,000
Allocable part of amount to be received annually
(($10,000 ÷ $21,053) × $1,200) $570
Duration of guaranteed amount ($10,000 ÷ $570) 17.5 yrs.
Rounded to nearest whole number of years 18
Percentage in Table III for age 65 and 18 years 30%
Present value of refund feature rounded to nearest dollar
(30% of $10,000) $3,000
Adjusted pre-July 1986 investment in the contract ($10,000 – $3,000) $7,000
Post-June 1986 adjustment:
Unadjusted investment in the contract $11,053
Allocable part of amount to be received annually
(($11,053 ÷ $21,053) × $1,200) $630
Duration of guaranteed amount ($11,053 ÷ $630) 17.5 yrs.
Rounded to nearest whole number of years 18
Percentage in Table VII for age 65 and 18 years 15%
Present value of refund feature rounded to nearest dollar)
(15% of $11,053) $1,658
Adjusted post-June 1986 investment in the contract ($11,053 – $1,658) $9,395

Once the investment in the contract has been adjusted by subtracting the value of the refund or period-certain guarantee, an exclusion ratio is determined in the same way as for a straight life annuity. The expected return is computed, then the adjusted investment in the contract is divided by expected return. Taking the two examples above, the exclusion ratio for each contract is determined as follows.

Example (3) above.




































Investment in the contract (adjusted for refund guarantee) $17,895
One year’s guaranteed annuity payments (12 × $100) $1,200
Life expectancy from Table V, age 65 20 yrs.
Expected return (20 × $1,200) $24,000
Exclusion ratio ($17,895 ÷ $24,000) 74.6%
Amount excludable from gross income each year in which 12
payments are received (74.6% of $1,200)* $895.20
Amount includable in gross income ($1,200 – $895.20)* $304.80

* Since the annuity starting date is after December 31, 1986, the total amount excludable is limited to the investment in the contract; after that has been recovered, the remaining amounts received are includable in income. However, if the annuity has a refund or guarantee feature, the value of the refund or guarantee feature is not subtracted when calculating the unrecovered investment.2

Example (4) above.







































































Pre-July 1986 investment in the contract (adjusted for period certain
guarantee) $7,000
One year’s guaranteed annuity payments (12 × $100) $1,200
Life expectancy from Table I, male age 65 15 yrs.
Expected return (15 × $1,200) $18,000
Exclusion ratio ($7,000 ÷ $18,000) 38.9%
Post-June 1986 investment in the contract (adjusted for period certain
guarantee) $9,395
One year’s guaranteed annuity payments (12 × $100) $1,200
Life expectancy from Table V, age 65 20 yrs.
Expected return (20 × $1,200) $24,000
Exclusion ratio ($9,395 ÷ $24,000) 39.1%
Sum of pre-July and post-June 1986 ratios 78%
Amount excludable from gross income each year in which 12 payments
are received (78% of $1,200)* $936
Amount includable in gross income ($1,200 – 936)* $264

* Since the annuity starting date is after December 31, 1986, the total amount excludable is limited to the investment in the contract; after that has been recovered, the remaining amounts received are includable in income.





1.     Treas. Reg. § 1.72-7(b).

2.     IRC § 72(b)(4).


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