Non-Qualified Annuities — What You Need to Know About Them

A non-qualified annuity is a contract designed to provide you with regular, guaranteed income during your retirement years. Non-qualified annuity policies are started with money which has already been taxed.

Non-qualified annuities can be a nice addition to a well-rounded portfolio. They can ensure that you have regular, predictable income on top of your Social Security benefits during retirement.

While they are funded with after-tax money, non-qualified annuities give the benefit of letting your money grow tax-deferred. In certain situations, they may also help reduce your overall taxable income in retirement, which can lower how much of your Social Security benefits might be taxed.

Another use for a non-qualified annuity is if you wished to retire early (say in your early 60s). It can fill in any income gaps between your monthly expenses in retirement and what your other assets may generate for cash-flow.

Here’s a closer look at how non-qualified annuities work and how they can be adapted for different situations in a retirement financial plan.

How Does a Non-Qualified Annuity Work?

When you purchase a non-qualified annuity, you are signing a contract with an insurance company. Your contract is started with money has already been taxed, and the insurance company will provide you with certain contractual benefits in return for your premium money.

Annuities are one of the few ways to actually tap into a guaranteed income for life, but there is a veritable buffet of annuity types. You will want to do your research and speak with a financial professional before committing to one.

Differences Between Qualified and Non-Qualified Annuities

The primary difference between a qualified and a non-qualified annuity is the tax status of the annuity premium. It depends on whether you started your annuity with money that has already been taxed, or money that hasn’t yet been taxed.

Unlike non-qualified annuities, qualified annuities are funded with pre-tax money, or money that you haven’t paid taxes on. The funds for a qualified annuity often comes from an employer plan, such as a 401(k), or a traditional IRA – in other words, from a retirement account that lets you save money on a tax-advantaged basis.

This distinction becomes important when you begin receiving benefits from your annuity. These two types of annuities are treated very differently for tax purposes at withdrawal.

Non-qualified annuities can also be referred to as after-tax annuity contracts. The premiums you pay into a non-qualified annuity aren’t tax deductible.

Key Features and Benefits of a Non-Qualified Annuity

One of the key features of a non-qualified annuity is that you can choose your payout duration.

Want to receive regular payments over a certain period of time? Perhaps you would rather have guaranteed income for the rest of your life, even if your contract runs out and you “outlive” your plan? Annuities can do either one, depending on how you set them up.

Some other benefits of non-qualified annuities include their flexible withdrawal terms and the fact that only your earnings are taxed at withdrawal.

Another notable feature of annuities is that there is no yearly cap on contributions. You can even have multiple annuities and stack their benefits like a ladder when it is time to retire and begin collecting income from your contracts.

Non-Qualified Annuities and Required Minimum Distributions

One sometimes overlooked benefit of a non-qualified annuity is its flexibility. You can start collecting income from it when you might need it.

There is no mandatory distribution rule that requires you to pull your money out once you reach a certain age. In contrast, qualified annuities, and retirement accounts like a traditional IRA, will require you to begin taking distributions once you reach certain ages in your 70s. These withdrawals are known as required minimum distributions (RMD).

Should you begin taking income from your annuity before the age of 59.5, there is a 10% IRS early withdrawal penalty on top of any federal income taxes due.

It’s also possible that the insurance company that issued your annuity may have some conditions or limits for distributions, such as it may require you to start income at a certain age if you haven’t. But many don’t – ask your financial professional if these circumstances apply to any annuity products that you are discussing.

With a non-qualified annuity, you can leave your money alone until you need it. This can be helpful feature in the case of an emergency.

For example, you could wait on starting your annuity income until you have a triggering event – for example, a health incident that leads to you spending time in a long-term care facility.

In circumstances such as those, some annuity contracts help you cover expenses tied to that, and even increase your payout, should you need to pay for specific long-term care costs.

If you pass away without using those funds, then the money inside your annuity can go to your beneficiaries instead.

Are Non-Qualified Annuities Taxable?

Non-qualified annuities have deferred taxes. You aren’t going to pay taxes on your money in the annuity until you begin receiving your money.

With a non-qualified annuity, you won’t pay taxes on the distribution of your principal (the money you initially put in) since you have already paid taxes on it beforehand. Instead, you are only required to pay taxes on the earnings that you receive.

Sometimes retirees find that they are in a lower tax bracket after retirement than they were before they retired.

Being able to sidestep taxes on part of the money you receive (since you have technically already paid your taxes on that part), combined with the lower tax bracket, can mean more money in your pocket at the time of withdrawal.

Is An Inherited Non-Qualified Annuity Taxable?

If you inherit a non-qualified annuity, you will be required to pay taxes on any interest earnings that you receive as part of a payout. But you won’t be liable for taxes on the principal.

If you choose to withdraw money early (assuming that you aren’t 59.5 years old), you will be subject to the same penalties and interest that the original owner would have had to pay.

Spouses who inherit a non-qualified annuity usually have the opportunity, via spousal continuation, to continue the annuity without paying additional taxes.

How Can You Start a Non-Qualified Annuity?

You can use a variety of funds to start a non-qualified annuity. Annuities can be a good option for money that is sitting around in a savings account but not earning much interest.

This is a good choice if you won’t need the money for a number of years and won’t need access for a while (you can still have some liquidity with free withdrawals of up to 10% from the contract, though).

Additionally, you could buy an annuity with funds from selling off property or other large assets.

Should you decide to sell stocks or use funds from an investment account be aware that you will be charged capital gains taxes on the sale of your stock.

Unlike stocks and similar assets that are subject to capital gains tax, annuities are subject to income taxes. You will want to be sure that the benefits of your annuity offset this downside with tax treatment.

Among other things, a non-qualified annuity can give you more compounding with tax-deferred growth, pay a guaranteed lifetime income, or counter other risks held in other portfolio assets.

Non-Qualified Annuities and 1035 Exchanges

What happens if you purchase an annuity, but later decide that a different type of annuity or option would better meet your financial goals?

If this happens, you can take advantage of Internal Revenue Code 1035. This part of the IRS code allows you to do a ‘1035 exchange,’ or where you swap one type of annuity for another tax-free.

Are Non-Qualified Annuities Right for You?

It’s best to talk to someone before committing to an annuity contract. You can get an opinion from an independent financial professional.

If you do have questions about annuities and what they can do for you, a financial professional can look at your individual situation. Based on your circumstances, they can help you discover what might be right for your financial goals.

For your convenience, many independent financial professionals are available here at You can connect with someone directly via our “Find a Financial Professional section Or, if you would like a personal referral give us a call at 877.476.9723.

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