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Qualified & Non-Qualified Annuities



What is the difference between a “qualified” and “non-qualified” annuity?

The IRS looks at funds in terms of qualified or non-qualified, in order to determine that money’s taxability. If money is non-qualified, that means it is not part of a tax-deferred account. Examples of tax deferred account are traditional or Roth individual retirement account (IRA), a simplified employee pension (SEP) or an employer sponsored defined benefit plan such as a 401(k). Taxes have already been paid on non-qualified money. Examples of non-qualified accounts are simple savings, money market accounts, or inheritance.

Qualified Funds

Qualified Funds are moneys eligible to be placed in tax deferred wealth accumulation vehicle that is approved by the IRS. It is important to note that the money placed in one of these accounts must be earned income. One of the major benefits of annuities is that the money that qualified money that is placed in an annuity is often subject to lower tax liability due to the fact that that it is tax deductible. The distribution of income and the taxes paid are deferred until a later point in time, most often after the owner of the annuity has retired.

Qualified accounts do not allow you to take your money until you are age 59 ½. If the account holder does so, it is standard procedure that the IRS will take 10% of the account’s value, and the account is still subject to normal taxation after that point (as yearly income).

One drawback for investors is that income taxes are typically higher than capital gain taxes. The IRS views all income taken from qualified accounts as income for that year, and thus, is taxed at a higher percentage than it would be as a capital gain.

Non-Qualified Annuities: Immediate and Deferred

Funding for a non-qualifies immediate annuity typically comes from the rollover of a single premium (one-time payment). Since that money has already been taxed, the only portion of the policy that is eligible for taxation is the wealth accumulation on it. Therefore, this option makes the most sense for a recent retiree who is looking to immediately take income on their policy.

Non-Qualified variable annuities function in a much different way. The money that is invested in the policy is placed specific stocks, bonds, etc. that are chosen by the annuitant. The gains do not incur any taxation until that income is taken by the policy holder. This also differs from other financial investments that are purchased with after tax dollars. For example, the interest earned on a savings or money market account funded with after tax dollars is not tax-deferred.

The biggest advantage of a tax-deferred account is the fact that potential accumulation will be at its maximum due to the fact that the policy is not incurring income taxes. The second benefit is that the annuitant will most likely be in a lower tax bracket once they retire and start taking income, so the policy will be taxed at a lower percentage.

Purchasing a non-qualified variable annuity can also provide an additional retirement savings advantage for an investor who has already contributed the maximum dollar amount allowed to a qualified plan. The income on variable annuities is susceptible to market fluctuation, though, so there is risk involved. A client looking for a guaranteed monthly stream is better off purchasing a non-qualified immediate annuity.

There is not a limit on the amount of non-qualified money that can be placed in an annuity or the amount of annuities that can be purchased. It is important to be advised that annuities are not considered to be a “liquid” investment, so the purchase should be made with money you are comfortable without, at least in the short term.

Both non-qualified and qualified annuities can be important pillars in a balanced financial portfolio. The idea is to be able to see the effects that the accumulation and distribution periods will have on the long term financial goal structure. Setting clear retirement goals and working with a certified financial planner can aid a policy holder to purchase the product most suited for their financial situation. Investors are encouraged to read the annuity fine print carefully and consult a tax advisor before making any serious purchases.

Annuity Surrender

A surrender charge is a cost incurred by an annuitant cancelling their annuity prematurely. Standard procedure is that an annuity will have a contract life of somewhere between 6 and 10 years. The surrender charge is based on the amount of time that the annuity has been in the client’s possession (the longer the annuitant has had the annuity, the lower the surrender charge).

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