Exclusion Ratio

The ratio of the number of people inside a nightclub compared to the number of people waiting outside by the velvet ropes.

Also, a measure of what percentage of an investment return is not subject to taxation.

You put $1,000 into an investment. When you sell it, you end up with $1,100. However, $1,000 of that amount was your original investment, not a taxable gain. The government doesn't get a piece of the money...you had it already. So only the $100 profit is taxable. The exclusion ratio here is 90.9%.

However, some investments aren't as straightforward. If you contribute sums to a tax-deferred investment over a long period of time, with different dollars earning different long-term return rates, determining the exclusion ratio can get more complex.