How does a nonqualified annuity work?

When you purchase a nonqualified annuity, you are using taxable dollars to secure a pension-like stream of income in retirement. You can usually pay the premium up front, or in installments, and designate the date in which you would like to start receiving income. Typically, income payments will be sent to you monthly by the issuing insurer and will continue for the duration of the annuity contract (some are guaranteed to last a lifetime).

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Annuity basics

An annuity is an insurance product that allows you to build or convert some of your retirement savings into a stream of guaranteed1 income payments that last for life, much like a pension. With an annuity as part of your retirement strategy, you will never be at risk of outliving your savings.

Related: Guide to annuities

Qualified annuities vs. nonqualified annuities

While it’s easy to get confused by the various types of annuities, the difference between qualified vs. nonqualified annuities is simple. It all comes down to how the money used to purchase the annuity will be taxed. Let’s take a look at the difference:

Qualified = pretax contributions

With a qualified annuity, the money you pay your premium comes from pretax dollars. That means you will not pay any taxes on this money, or any growth it achieves, until it is withdrawn (as is the case with a traditional IRA or any other qualified retirement account). This gives your money the ability to grow faster, which can add up significantly over time. However, qualified accounts have contribution limits and come with additional restrictions governed by the Internal Revenue Code. When you withdraw money from a qualified annuity, it is taxed at the ordinary income rate.

Nonqualified = after-tax contributions

With a nonqualified annuity, the money you pay the premium comes from after-tax dollars, so there is no “up-front” tax benefit. When you take withdrawals, however, the money you put in can be withdrawn tax free (only the growth is taxed). You can also fund a nonqualified annuity as much as you want (up to the limit of the annuity contract), without having to worry about the restrictions the IRS places on qualified plans.


How many types of nonqualified annuities are there?

There are a lot of different annuities on the market—some qualified and some nonqualified. To make sense of it all, you may find it helpful to know that the type of annuity is often defined by the following factors/choices:

Immediate vs. deferred: With an immediate annuity, payments start right away, and with a deferred annuity, payments begin at a future date. For both qualified and nonqualified deferred annuities, withdrawals prior to age 59 ½ are subject to not only the applicable income tax, but also 10% IRS penalty. There may also be surrender charges. 

Fixed, variable, or indexed: Since annuity owners typically have different levels of risk tolerance, there are different types of annuities – varying in their risk and return profile.


How is a nonqualified annuity taxed?

With a nonqualified annuity, you do not have to pay taxes on the principal (the money you pay in), only on any growth that takes place. When the time comes for you to get money back, any growth reflected in your income payments will be treated as ordinary income by the IRS.


What other benefits do nonqualified annuities offer?

In addition to tax-deferred growth and a steady stream of income in retirement, most annuities will pay your beneficiaries a death benefit if you pass away before your income payments begin, and sometimes even well after they have started.

Related: Shop for annuities


Is this type of annuity right for me?

While both qualified and nonqualified annuities can provide income for life, they operate a little differently and are designed to meet a distinct set of needs. Our agents can walk you through how they work, step by step, and help you decide which type is best for you.

Neither New York Life Insurance Company, nor its agents, provides tax, legal, or accounting advice. Please consult your own tax, legal, or accounting professional before making any decisions.

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