How a SPIA Is Taxed: The Exclusion Ratio Explained With a Real Example

Kevin Wenke

CFP | CLU | Investing | Insurance | Financial Planning

July 26, 2026
, Annuity

A Single Premium Immediate Annuity turns a lump sum into guaranteed income — but not all of that income is taxed the same way. Part of every payment is a tax-free return of your own money; part is taxable earnings. The percentage that's tax-free is called the exclusion ratio, and it's set once, at the start of your contract, using a fixed federal formula.

Compare that to what happens if you'd kept the same lump sum in a CD or savings account instead. There, the tax rules are simple and far less forgiving: every dollar of interest is taxed as ordinary income the year it's earned — whether you withdraw it or leave it sitting in the account. There's no "return of principal" concept at all. The IRS already knows exactly which dollars were your original deposit and which are growth, and it taxes the growth every single year, regardless of what you do with it.

A SPIA doesn't work that way. Instead of taxing growth as it happens, the IRS taxes each payment using a ratio fixed at the very start of the contract — treating a portion of every check as a tax-free return of your own premium, for as long as that premium lasts. That difference in timing is often the single biggest reason a SPIA ends up more tax-efficient than the equivalent income drawn by hand from savings — and it's the part of SPIA taxation almost nothing online explains clearly.

Here's where the SPIA side of this typically goes slightly wrong, though.

The common version: "Your exclusion ratio is based on your life expectancy."

What's actually true: There are two different life-expectancy numbers involved in a SPIA, and they come from two completely different places. Your insurance company uses its own mortality and expense assumptions — a private, competitive business decision — to calculate your monthly check. The IRS uses a separate, publicly published actuarial table to calculate how much of that check gets taxed. These two numbers don't need to match, and in practice they rarely do exactly.

We know that's a lot to hold in your head at once — a CD taxed one way, an annuity taxed another, and two different "life expectancy" numbers in play. That's exactly why we built the tool below around one real premium and one real set of numbers. Drag the age slider and pay attention to the taxable amount in each row as the years pass — it tells the whole story.

See How Much Tax and Residual Value Robert Has, in Three Different Scenarios

Robert is 72 and put $300,000 into a SPIA paying $27,600 a year for life. Drag the slider to any age up to 120 and compare that against a CD/savings account drawing the same $27,600 a year, and a SPIA with a refund guarantee — which pays somewhat less on the same $300,000, since part of the premium now funds the guarantee.

Age: 72

Scenario	Payment this year	Taxable this year	Total received to date	Residual value	Status
CD / Savings	—	—	—	—	—
SPIA with refund option	—	—	—	—	—
SPIA, life income only	—	—	—	—	—

Illustration only — assumes a $300,000 premium, $27,600/year life-only income, an illustrative 12% lower payout for the refund-option version, and an illustrative 4.5% savings rate (a live market-rate feed replaces this once embedded live). Both the refund payout reduction and its tax adjustment are representative, not exact carrier or IRS Table VII figures for this specific age and guarantee period. Actual figures vary by carrier, contract, and current rates.

If you dragged the slider above, here's what you should have seen: the CD/savings account's taxable amount gets a little smaller every year, right alongside its shrinking balance — until the account runs dry and the payments stop completely. Both SPIA versions do something entirely different. Their taxable amount stays exactly the same, year after year, for as long as the exclusion ratio is in effect — then, once that ratio has done its job, it jumps straight to the full payment amount and stays there, fully taxable, for the rest of the annuitant's life, no matter how long that turns out to be.

That isn't a quirk of the tool. It's the direct, mechanical result of how the General Rule works — walked through step by step below.

The IRS General Rule, in Plain Terms

For most nonqualified SPIAs — ones purchased with after-tax savings — the taxable portion of your payment is governed by IRS Publication 939, under what the IRS calls the General Rule. It comes down to a single ratio:

Exclusion Ratio = Investment in the Contract ÷ Expected Return

Investment in the contract is your net premium — the after-tax money you put in.

Expected return is what the IRS assumes you'll collect over your lifetime, and this is where the standardized table comes in. For a single-life SPIA, the IRS multiplies your annual payment by a life-expectancy multiple from Table V — a unisex table, keyed only to your age at the annuity starting date, found in Publication 939. It has nothing to do with your health, your sex, or the mortality assumptions your carrier used to price your contract.

The IRS's own four-step process is straightforward:

1. Figure your investment in the contract (your net premium).
2. Figure your expected return (annual payment × the Table V multiple for your age).
3. Divide the first by the second, rounded to three decimal places — that's your exclusion ratio.
4. Apply that percentage to every payment you receive, for as long as the contract pays.

A Full Worked Example

Robert (a composite built from clients Kevin has worked with over the years) is 72 years old. He buys a straight-life SPIA with $300,000 of after-tax savings, and the carrier quotes him $2,300 a month — $27,600 a year — for as long as he lives.

Here's how the IRS figures his taxes, step by step:

Step	Calculation	Result
Investment in the contract	Robert's net premium	$300,000
Table V multiple, age 72	From IRS Pub. 939	14.6
Expected return	$27,600 × 14.6	$402,960
Exclusion ratio	$300,000 ÷ $402,960	74.4%
Tax-free portion, per year	74.4% × $27,600	$20,534.40
Taxable portion, per year	$27,600 − $20,534.40	$7,065.60

Every year, for as long as Robert receives payments, 74.4% of his $27,600 is tax-free — $20,534.40 — and the remaining $7,065.60 is taxed as ordinary income. That ratio doesn't shift if he lives 5 more years or 35 more.

What Happens When You Outlive the Table

The tax-free portion doesn't continue forever. Once Robert's cumulative tax-free payments add up to his full $300,000 investment, every payment after that becomes 100% taxable.

At $20,534.40 a year, that takes about 14.6 years — meaning around age 86 or 87, Robert's exclusion ends. Not because the contract changes, and not because the IRS revisits his age. It ends simply because there's no more principal left to return. If Robert lives to 95, or past 100, the payments keep coming — they're just fully taxable from that point forward.

When a Refund Option Changes the Math

If Robert's contract includes a cash refund, installment refund, or period-certain guarantee, the calculation gets one extra step first. Because part of his premium is now paying for a beneficiary guarantee rather than pure lifetime income, the IRS requires you to reduce your investment in the contract before dividing — using a separate table, Table VII, before you ever calculate the exclusion ratio itself. Almost nothing else written about exclusion ratios online covers this step.

The IRS's own published example shows how it works: a 65-year-old buys an annuity with a refund feature for a $21,053 net cost, paying $100 a month for life, guaranteed to a beneficiary until the full $21,053 is returned. Dividing the guarantee ($21,053) by the annual payment ($1,200) gives roughly 17.5 years, rounded to 18. Table VII's percentage for age 65 with an 18-year guarantee is 15% — so the value of the refund feature is $3,158 (15% of $21,053). That amount gets subtracted from the net cost before the exclusion ratio is calculated, dropping the investment in the contract from $21,053 to $17,895.

The takeaway: adding a refund option doesn't just lower your monthly check (covered in SPIA Payout Options Compared) — it also lowers the base number your exclusion ratio is calculated from, since part of your premium is now earmarked for the beneficiary guarantee rather than your own income. That's exactly why Robert's refund-option payment in the tool above is lower than his life-only payment on the same $300,000 — the guarantee has a real cost, on both sides of the ledger.

Joint-Life Contracts Use a Different Table Entirely

If you and a spouse are both covered under the same SPIA, Table V doesn't apply at all. The IRS uses Table VI instead, which is built around your combined ages rather than either person's individually. In the IRS's own example, a 70-year-old and a 67-year-old spouse receiving $500 a month use a joint multiple of 22.0 — noticeably higher than either person's individual Table V multiple would be, because the payments are expected to run longer across two lives.

The mechanics of joint-and-survivor SPIAs — including how the survivor percentage you choose affects your income — are covered in full in Joint and Survivor SPIAs.

What Happens If You Don't Reach Full Recovery

The flip side of outliving the table is dying before it. Say Robert passes away 5 years into his contract, having received 5 payments of $27,600 — $138,000 total, of which $102,672 (74.4%) was tax-free.

That leaves $197,328 of his original $300,000 investment still unrecovered — money the IRS assumed he'd eventually get back tax-free, but never did, because the payments stopped at his death.

Under IRC §72(b)(3), that unrecovered amount isn't simply lost. It's allowed as a deduction on Robert's own final individual income tax return — the return covering his last taxable year, typically prepared by his executor. This only applies if there's no surviving annuitant continuing to collect payments; a joint-and-survivor SPIA generally passes the same exclusion ratio to the survivor instead, with no unrecovered-investment deduction at that point.

Two details worth knowing about this deduction: it's specifically carved out of the "miscellaneous itemized deduction" category under IRC §67(b)(10), which means it was never subject to the usual 2% of adjusted-gross-income floor, and it wasn't affected by the 2018–2025 suspension of miscellaneous itemized deductions under the Tax Cuts and Jobs Act. It survived that suspension because it was never classified as one of the deductions being suspended in the first place.

Reading Your 1099-R

Each year, your carrier sends a Form 1099-R reporting what you received. Broadly, here's what shows up:

Box 1 (Gross Distribution) — your full payment for the year. For Robert, $27,600.

Box 2a (Taxable Amount) — the portion your carrier calculated as taxable, using the exclusion ratio already established at your annuity starting date. For Robert, this should read $7,065.60.

Box 2b — a checkbox your carrier marks if they weren't able to determine your taxable amount for you. If it's checked, Box 2a may be blank, and you (or your tax preparer) apply the General Rule yourself.

Box 5 — often used to show the nontaxable portion of your distribution, though exactly what a given carrier reports here can vary. If populated, it's generally the difference between Box 1 and Box 2a.

Carriers handle these boxes with some variation in practice, so treat your specific 1099-R — and your tax preparer's reading of it — as controlling over any general description here.

If Your SPIA Was Funded With IRA Money

Everything above assumes a nonqualified SPIA — funded with after-tax savings. If your premium instead came from a traditional IRA or other pre-tax retirement account, none of this applies: there is no exclusion ratio, and 100% of every payment is taxable as ordinary income, because none of that money was ever taxed going in. The full breakdown — including Roth-specific rules and how after-tax IRA basis is handled under the pro-rata rule — is covered in SPIA Funded by an IRA vs. After-Tax Savings.

Frequently Asked Questions...

Does my exclusion ratio change if I live longer than the IRS assumed?

No. It's fixed once, at your annuity starting date, using the Table V multiple for your age at that time. Living longer than the table assumed just means more years of fully taxable payments once your basis is recovered — not a different ratio.

Does this apply if I bought my SPIA before 1987?

No — pre-1987 contracts follow older, more favorable rules that can let the tax-free exclusion continue indefinitely, even past full cost recovery. Most SPIAs issued today follow the rules described above.

What if I chose a joint-and-survivor SPIA?

The mechanics change — Tables VI/VIA replace Table V, and the survivor generally inherits the same exclusion percentage. See Joint and Survivor SPIAs for the full walkthrough.