What is the exclusion ratio used for in relation to annuities?

The exclusion ratio is a key calculation used in the context of annuities to determine the portion of the annuity payments that are subject to income tax and the portion that is considered a return of the original investment, which is not taxable. When an individual receives periodic payments from an annuity, a part of each payment is considered a return of the principal investment, and therefore, that part is not taxed. The exclusion ratio helps in calculating how much of each annuity payment can be excluded from taxable income.

This calculation is crucial because it ensures that individuals do not pay taxes on their own invested money. The exclusion ratio is typically determined by dividing the total investment in the annuity by the expected total payments over the annuitant's life expectancy, thus allowing the annuitant to receive a portion of their income tax-free.

In the context of the choices provided, this understanding of the exclusion ratio aligns perfectly with the function described in relation to tax exemptions on annuity income, making that option the correct choice.