What Is a Non-Qualified Annuity?

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An annuity is a contract between an annuitant and an insurance company. The annuitant makes an initial investment, or ongoing contributions over time, so the insurance company will later pay out to a beneficiary based on the appreciation of the investment. When used as a retirement savings vehicle, the annuitant is also the beneficiary, and the annuity is set to pay upon retirement.

Retirement Savings

Annuities are popular for retirement savings because they offer flexibility. In many cases, you can defer income and capital-gains taxes while receiving a guaranteed income stream for life. Some employers offer annuity plans and are willing to match contributions made from an employee's paycheck. Combined with other forms of savings, such as a 401(k), annuities can be an important foundation of a comfortable retirement lifestyle.

Qualified Vs. Non-Qualified

The Internal Revenue Service classifies annuities into two basic types. Qualified annuities are principally those purchased through an employer and which qualify for tax deferral. In other words, the employer is allowed to fund the qualified annuity with pre-tax dollars from an employee's earnings. Privately obtained annuities that cannot be funded with pre-tax dollars are called non-qualifying annuities.


In most ways, a non-qualified annuity functions just like one purchased through a qualified employer. The money is subject to penalties for early withdrawal, income can be immediate or deferred and you have various investment options. The principal difference, however, is that non-qualified annuities are not subject to federal laws governing contribution caps and mandatory withdrawals.

Tax Impact

Because it is funded with after-tax dollars, the initial investment to a non-qualified annuity is not subject to tax on disbursement after retirement. This is in contrast to a qualified annuity that becomes subject to state and federal taxes in its entirety as funds are disbursed. Only the capital gains realized on a non-qualified annuity are taxed upon distribution.


At retirement, the proceeds of an annuity usually can be distributed either in a lump sum or in regular payments for life. If the principal of a non-qualified annuity has appreciated since the initial investment, a lump-sum payment can trigger a significant tax liability, particularly if it moves the annuitant into a higher tax bracket for the year. Electing to receive regular payments, however, is unlikely to do so, and because only the capital gains are taxed, the effective rate will be low.