What Is a Non-Qualified Annuity?

kate_sept2004 / Getty Images

Commitment to Our Readers

GOBankingRates' editorial team is committed to bringing you unbiased reviews and information. We use data-driven methodologies to evaluate financial products and services - our reviews and ratings are not influenced by advertisers. You can read more about our editorial guidelines and our products and services review methodology.

20 Years
Helping You Live Richer

Reviewed
by Experts

Trusted by
Millions of Readers

A non-qualified annuity is a type of investment product that lets your money grow tax-deferred until you start taking withdrawals. Unlike qualified annuities, which are funded with pre-tax dollars from accounts like IRAs or 401(k)s, non-qualified annuities are funded with after-tax money. This means you’ve already paid taxes on the money you invest, but the growth accumulates tax-free until you withdraw it.

If you’re looking for a way to grow your retirement savings without the limits of traditional retirement accounts, a non-qualified annuity could be a smart choice. In this guide, we’ll break down how they work, their tax implications, pros and cons and help you decide if they’re the right investment for your financial goals.

Non-Qualified Annuity Meaning: What Is It Exactly?

A non-qualified annuity is an insurance contract that allows you to invest after-tax money and benefit from tax-deferred growth. Here’s what sets it apart:

• Funded with After-Tax Dollars: You don’t get a tax deduction when you contribute because you’ve already paid taxes on the money.
• Tax-Deferred Growth: Your investment gains are not taxed until you withdraw them, allowing your money to grow faster.
• Flexible Contribution Limits: Unlike 401(k)s or IRAs, there are no contribution limits, so you can invest as much as you want.
• No Required Minimum Distributions (RMDs): You’re not required to take distributions at a certain age, giving you more control over your retirement income.

Types of Non-Qualified Annuities

Depending on your risk tolerance, you can choose from three different types of annuities. Always ask a financial advisor about associated fees and costs to find the best product for you.

Fixed Annuity

A fixed annuity promises a specific rate of return and doesn’t fluctuate based on the stock market or the federal fund’s target interest rate. At times, the company holding the annuity may offer a higher interest rate for a limited time, but the rate will not drop below the fixed rate.

Variable Annuity

A variable annuity, as the name implies, delivers returns based on the performance of the stocks that make up the annuity.

Fixed Indexed Annuity

A fixed indexed annuity delivers the best of both worlds. This investment is tied to the stock market, typically an index like the Nasdaq or S&P 500, but comes with a guarantee that the interest won’t drop below a set minimum, even if the stock index underperforms.

How Do Non-Qualified Annuities Work?

Here’s a basic explainer about the nitty-gritty details of how a non-qualified annuity works. Here’s the important stuff you’ll need to know:

1. Contribution Rules

• You fund a non-qualified annuity using after-tax dollars — money that’s already been taxed.
• There are no IRS-imposed contribution limits, making it an attractive option if you’ve maxed out your other retirement accounts.

2. Tax-Deferred Growth

• The money in your annuity grows tax-deferred, meaning you don’t pay taxes on the earnings until you withdraw them.
• This allows for compound growth over time, accelerating the accumulation of wealth.

3. Payout Options

Non-qualified annuities offer flexible payout options:

• Lump Sum: Withdraw the entire amount at once (taxes due on the earnings portion).
• Periodic Withdrawals: Take distributions as needed, paying taxes only on the earnings.
• Lifetime Income Payments: Convert your annuity into a guaranteed income stream for life, protecting against the risk of outliving your savings.

Tax Implications of Non-Qualified Annuities

One of the major upsides of parking your money in an annuity is the tax advantages. That’s one of the reasons they’re so popular with retirees. Let’s dig into some of the basics you’ll need to know about non-qualified annuity tax implications:

1. How Are Withdrawals Taxed?

Withdrawals from a non-qualified annuity are partially taxable:

• Principal (your contributions) = Tax-free because you already paid taxes on this money.
• Earnings (interest, dividends, gains) = Taxed as ordinary income when you withdraw.

2. Last In, First Out (LIFO) Rule

Most non-qualified annuities use the Last In, First Out (LIFO) rule, meaning:

• Earnings are taxed first when you make withdrawals.
• Your principal is withdrawn tax-free only after all earnings have been taken out.

3. Tax Treatment for Beneficiaries

If you pass away before depleting the annuity:

• Beneficiaries are taxed on the earnings portion, but not the principal.
• They can choose to take the payout as a lump sum or stretch it over time to spread out the tax burden.

Non-Qualified Annuity vs. Qualified Annuity

Sorting out the differences between certain annuities can be tough. Here’s the basic breakdown of each that helps highlight those differences:

Which Is Right for You?

• Choose a non-qualified annuity if you’ve maxed out other retirement accounts and want tax-deferred growth with flexible withdrawals.
• Choose a qualified annuity if you want an immediate tax deduction and don’t mind the restrictions on contribution limits and RMDs.

Pros and Cons of Non-Qualified Annuities

Here are some of the advantages and drawbacks of non-qualified annuities:

Pros

• No Contribution Limits – Ideal for high-income earners who want to save more for retirement.
• No Required Minimum Distributions (RMDs) – Greater flexibility in managing withdrawals.
• Tax-Deferred Growth – Reduces annual tax liability on investment earnings.
• Guaranteed Income Options – Can provide a steady income stream in retirement.

Cons

• Earnings Are Taxed as Ordinary Income – Potentially higher tax rates compared to capital gains.
• Limited Liquidity – Early withdrawals before age 59½ may incur a 10% penalty.
• Complex Fee Structures – High management fees and surrender charges.

How to Purchase a Non-Qualified Annuity

Now that you know the basics of non-qualifed annuities, let’s dig into how to get one. After all, grabbing the right annuity might be the key to a more comfortable retirement. Here’s a step-by-step breakdown for getting one of your own:

1. Research Providers

• Look for financially strong insurance companies with high ratings from A.M. Best, Moody’s or Standard & Poor’s.
• Compare fees, investment options and payout structures.

2. Compare Fees and Features

• Surrender Charges – Fees for early withdrawals, typically within 5-10 years.
• Rider Costs – Optional benefits like lifetime income or long-term care add to the cost.
• Investment Options – Choose between fixed, indexed or variable annuities based on your risk tolerance.

3. Consult a Financial Advisor

Work with a fiduciary financial advisor who acts in your best interest and provides objective advice.

Final Thoughts to GO: Should You Consider a Non-Qualified Annuity?

Non-qualified annuities can be a valuable tool for tax-deferred growth and retirement income. If you’ve maxed out other retirement accounts and want flexibility in withdrawals, a non-qualified annuity is worth considering.

Information is correct as of Feb. 19, 2025.

Editorial Note: This content is not provided by any entity covered in this article. Any opinions, analyses, reviews, ratings or recommendations expressed in this article are those of the author alone and have not been reviewed, approved or otherwise endorsed by any entity named in this article.

Share This Article: