Non Qualified Annuity vs Qualified Annuity

Most annuities are technically non qualified annuity contracts, but if they are used to fund a qualified annuity account, they become qualified and any additional funds that are added must also be qualified. What exactly does qualified mean? Qualified annuity funds are funds that are placed in an Internal Revenue Service approved tax deferred annuity account. Qualified funds are pre tax dollars that are invested in a retirement program such as a traditional Individual Retirement Account, a Roth IRA, a simplified employee pension plan or an employer sponsored plan such as a 401(K). Non qualified funds are monies that have already been taxed and are invested as after tax dollars.

Any funds that are placed in a qualified  index annuity account must be generated from earned income. These contributions are often tax deductible and can lower the annuity owners current taxes. Non-qualified funds can be from the sale of a home, an inheritance or funds from a savings account or mutual funds. Qualified funds are usually distributed after the owner retires and the owner controls when the withdrawals are made and the taxes are paid. In past times, the owner would usually be in a lower tax bracket so the taxes would be less. In our current economic environment, taxes will probably have to be raised so an owner may not always be in a lower tax bracket after retirement.

Money in a qualified or non qualified annuity can not normally be withdrawn before age 59 ½ without incurring a penalty. There are exceptions such as medical hardship but consult with a tax professional before withdrawing the money. The withdrawal is irrevocable and if it is not rolled over within 60 days, it is fully taxable. Direct transfers are allowed between retirement account trustees without any tax consequences. However, surrender charges could apply. Check the contract language for charges before doing a direct rollover.

Some financial planners suggest it is not wise to use an annuity to fund a retirement account because it is redundant. The earnings of the non qualified annuity are already tax deferred and so are the earnings of a retirement account such as an IRA. However, because the annuity usually offers a higher yield, no stock market risk, financial security and limited liquidity it makes sense to fund a retirement account with an annuity.

An employer who wishes to set up a retirement plan for employees must get the plan “tax qualified” by the IRS if he wishes for the contributions to the account to tax tax deductible. The IRS must approve a sample plan and a trustee must be established to handle the plan. The employer can be the trustee or he can choose a financial institution or a plan administrator to be the trustee. In all cases, the employer still has a fiduciary responsibility to the employees. A vesting schedule must also be set up with the plan. The vesting schedule shows the ownership rights the employees have to the plans assets depending on how long they have been employed. In most plans, the employer and the employee can make contributions to the employee’s accounts.

In summary, a qualified annuity or a non qualified annuity can be used to fund a retirement account. The difference in the account is the tax treatment of the contributions and the withdrawals. The annuity usually offers higher rates, lower risk and limited liquidity.