What is what method is used to determine the taxable portion of each annuity payment?

The method used to determine the taxable portion of each annuity payment can vary depending on the type of annuity and how it was acquired.

For immediate annuities purchased with pre-tax funds, such as those held in traditional IRAs or employer-sponsored retirement plans, the taxable portion of each payment is typically calculated using the exclusion ratio formula. This formula takes into account the original investment in the annuity and the expected return on that investment over the annuitant's lifetime, in order to determine the portion of each payment that represents earnings subject to income tax.

For immediate annuities purchased with after-tax funds, such as those held in a non-qualified account, the taxable portion of each payment is generally calculated based on the annuitant's life expectancy and the expected return on the annuity contract.

In the case of deferred annuities, which are purchased with pre-tax or after-tax funds and accumulate earnings over time before payouts begin, the taxable portion of each payment is determined using the exclusion ratio method or the last-in-first-out (LIFO) method, depending on the specific circumstances of the annuity contract.

It is important for annuity holders to consult with their financial advisor or tax professional to understand the specific tax implications of their annuity payments and to ensure proper reporting of income to the IRS.