An annuity is a contract between you and an insurance company that guarantees a stream of income, often for life, in return for a lump-sum payment or a series of payments over time.
Unlike qualified annuities, which you can fund with pre-tax dollars usually held in a retirement plan like 401(k) or an individual retirement account (IRA), non-qualified annuities are purchased with money that's already been taxed. You won’t have to pay taxes on your initial investment again when you start collecting income payments.
And because non-qualified annuities don’t have contribution limits according to the IRS, they can help you complement your investment portfolio and prepare for retirement.
People who can benefit the most from non-qualified annuities are high earners who’re already maxing out contributions to any qualified plans available to them.
What is a non-qualified annuity?
A non-qualified annuity is a retirement savings plan with a unique feature: its lack of tax-exempt status. Unlike a qualified annuity, which can be funded with pre-tax dollars, a non-qualified annuity must be purchased with money that’s already been taxed. Qualified annuities are usually held in 401(k) or 403(b) plans — although they can also be held in IRAs.
Also, unlike a qualified annuity, employers generally don’t sponsor non-qualified plans. If you want to set up a non-qualified annuity, you’ll have to do that on your own through a life insurance company.
Learn more about other types of annuities
How do non-qualified annuities work?
With a non-qualified annuity, you’ll make payments with income or other money that’s already been taxed. Once you reach age 59½, you can start withdrawing from this fund without having to pay a penalty fee. You won’t have to pay additional taxes on the principal that you paid, but you’ll be taxed on any growth that’s accumulated. [1]
You also don’t need to withdraw money when you reach a certain age, like you have to with a qualified annuity.
Learn more about how annuities work
How do non-qualified annuities get funded?
You can fund a non-qualified annuity with your income, savings, an inheritance, gifts, or the sale of an asset. The only thing you can’t fund a non-qualified annuity with is your pre-tax income.
Non-qualified annuities are most often funded with savings or other post-tax investment accounts. You could also fund a non-qualified annuity with a Roth IRA in theory, but since Roth IRAs already come with tax advantages, this option usually isn’t the best fit.
Depending on how you want to invest your funds, your non-qualified annuity contract can be fixed, variable, or indexed.
If you want to start receiving payments right away, you can opt for a non-qualified immediate annuity. If you’d rather start withdrawing money in the future, you can buy a non-qualified deferred annuity instead.
Do annuities affect financial aid and other benefits?
Do non-qualified annuities have contribution limits?
No, non-qualified annuities don’t have contribution limits according to the IRS, which is one of their most attractive features. However, each insurer may set a limit for contributions to an individual contract.
These limits are typically significantly higher than limits to other qualified retirement accounts (for instance, an insurer might have a limit of $1 million per contract), and you can always purchase multiple contracts if need be.
If you’re already maximizing contributions to qualified annuities and want to invest additional after-tax dollars toward retirement, adding a non-qualified annuity contract to your investment portfolio can help.
What is the impact of interest rate changes on your annuity?
How are contributions taxed in a non-qualified annuity?
Since the money you put into a non-qualified annuity has already been taxed, you won’t have to pay taxes on the principal when you start withdrawing from the account. However, any growth you receive from the annuity will be taxed as income. [2]
Can you withdraw money from your annuity?
Do non-qualified annuities have distribution requirements?
The only distribution requirement for a non-qualified annuity is that you can’t withdraw funds until you reach age 59½ without incurring a 10% penalty. But after that, you can choose to withdraw or not withdraw funds as you see fit.
There are no required minimum distribution (RMD) requirements on a non-qualified annuity like there are on a qualified annuity. You can keep the money in your account for as long as you choose to.
How are distributions taxed in a non-qualified annuity?
When you withdraw money from a non-qualified annuity plan, you won’t have to pay taxes on the principal you paid — that money’s already been taxed. However, you’ll have to pay taxes on any growth the annuity has accumulated.
Can you lose money in an annuity?
What are the pros & cons of non-qualified annuities?
Non-qualified annuities can be a useful investment tool, but they’re not for everyone. Consider the pros and cons of a non-qualified plan before setting one up.
Pros
No IRS contribution limits. With a non-qualified annuity, you can put as much money as you choose into your account, provided you abide by your insurer’s guidelines. With a qualified annuity, you’ll have an annual limit imposed by the IRS on how much you can deposit.
Not required minimum distribution. Qualified plans force you to start withdrawing money by age 72 (or age 73 if you reach age 72 after Dec. 31, 2022), otherwise you’ll be subject to additional fees. [3] With a non-qualified annuity, you can leave the money in your account for as long as you like. You don’t have to withdraw it until you want to.
Cons
No tax benefits. You won’t be able to reduce the amount of your taxable income with a non-qualified annuity like you’d be able to with a qualified annuity.
Subject to surrender charges and other fees. If you do need to withdraw funds from your annuity before age 59½, you could face significant surrender charges.
Can annuities be used as a collateral for a loan?
What should you consider before buying a non-qualified annuity?
Before you purchase a non-qualified annuity, make sure you’ve considered your other investment options. For most people, the tax-deferred option included in a qualified annuity can be more advantageous.
Are annuities a good investment?
Who should consider non-qualified annuities?
Non-qualified annuities are best for people who’ve already maximized their investments in 401(k)s and IRAs and are willing to give up some liquidity to make a long-term financial investment.
“Also, annuities can trigger penalties if funds are withdrawn before age 59½, similar to retirement accounts,” says Zachary Bachner, certified financial planner at Summit Financial Consulting, LLC. “This means there is an aspect of flexibility that is sacrificed for the annuity, so these are only meant for long-term savings, especially due to the surrender schedules on the products.”
If you’re unsure whether or not a non-qualified annuity will fit into your retirement planning, speak with a financial advisor you can trust who can help you choose the right type of annuity or investment option for you.
How does an annuity fit into your overall retirement plan?
