Two numbers decide an annuitization election: how much income the contract produces, and how much of each payment the IRS lets you keep tax-free. This tool prices the payout from the account value, payment term and assumed return, then splits every cheque using the IRS Simplified Method and the general exclusion ratio side by side so you can see which one your contract qualifies for.
Every row below is computed by the page's own payment() and split() functions. The comparison that matters is between the two tax-free columns: the exclusion ratio spreads basis evenly, while the Simplified Method front-loads it based on the payout term, and the IRS lets you use the Simplified Method only when the contract is a life annuity or a qualified plan payout.
| Scenario | Value / basis | Term | Monthly payout | Exclusion ratio | Tax-free / mo | After-tax / mo |
|---|---|---|---|---|---|---|
| Non-qualified, 20-yr certain @5% | $250,000 / $180,000 | 20 yrs | $1,650 | 45.46% | $750 | $1,452 |
| Non-qualified, 15-yr @4% | $150,000 / $100,000 | 15 yrs | $1,110 | 50.07% | $556 | $977 |
| Mostly gain (little basis) | $200,000 / $50,000 | 20 yrs | $1,320 | 15.78% | $208 | $1,075 |
| Qualified rollover, zero basis | $400,000 / $0 | 25 yrs | $2,338 | 0.00% | $0 | $1,777 |
| Short 10-yr payout @6% | $300,000 / $300,000 | 10 yrs | $3,331 | 75.06% | $2,500 | $3,148 |
Payouts use the standard annuity present-value formula at the stated return, so a 20-year term at 5% returns roughly 7.9% of the account value each year — not 5%. The apparent "extra" is your own principal coming back. Annuitization is irreversible on most contracts; the quote is not a withdrawal you can undo.
Annuities are taxed under the exclusion ratio rule: investment in the contract divided by expected total return. The portion of each payment equal to that ratio is a tax-free return of your after-tax basis; the rest is ordinary income. After you have recovered the entire basis, every payment is fully taxable — a point most illustrations ignore.
IRS Publication 939 allows the Simplified Method for payments from a qualified plan, or from a non-qualified contract that guarantees payments for life (or life expectancy) with a refund feature. It replaces the projected-return calculation with a table of anticipated payments by age. For a term-certain payout with no life contingency, the general exclusion ratio is the only option.
A $250,000 contract with $180,000 of after-tax basis and $70,000 of gain will pay out $250,000 plus whatever the insurer earns during the payout phase. The exclusion ratio is fixed at the start: $180,000 ÷ total expected return. If the total schedule is $410,000, the ratio is 43.9%, so a $1,700 monthly cheque delivers about $747 tax-free and $953 taxable. At a 22% federal rate that is roughly $958 of spendable income per month, not $1,700.
Because the ratio is set once, a variable or indexed annuity that later raises the payment does not raise the tax-free dollar amount. The same $747 stays exempt and every dollar of increase is taxable. Retirees who bought a contract expecting inflation protection often discover the tax protection does not inflate with it.
Three routes out of an annuity, and each is taxed differently. A lump-sum surrender makes the entire gain taxable in one year, which can push you into a higher bracket and, for someone on Medicare, higher IRMAA premiums two years later. A lifetime annuitization spreads both the basis recovery and the gain across decades. A systematic withdrawal (1035 exchange into a payout or partial withdrawals) is taxed LIFO — earnings come out first and are fully taxable until basis is exhausted.
The 10% early-withdrawal penalty applies to gains taken before age 59½ from a non-qualified annuity, with a handful of exceptions including death, disability, and substantially equal periodic payments. Comparing a lump sum to a lifetime payout therefore requires the after-tax numbers, not the gross quotes — which is exactly what the columns above compute.
⚠️ Disclaimer: This calculator uses the standard annuity present-value formula and a simplified exclusion-ratio / Simplified Method split. Actual contract payouts depend on the insurer's rate sheet, guaranteed periods, riders and the exact IRS tables for your annuity starting date. It assumes level payments and a constant tax rate, ignores state tax, the 3.8% net investment income tax and IRMAA effects. Planning estimate only, not tax advice.