Retirement dreams and aspirations are as unique as the individuals who hold them. No matter the retirement lifestyle you desire, you need a solid strategy and diversified financial toolkit to get there.
Qualified and nonqualified annuities might be worth considering. Thanks to their proven ability to offer a predictable or even guaranteed lifetime income stream in retirement, these products have surged in popularity over the last few years. In fact, the annuity industry experienced record growth in 2023 and increased by 21.5% over the previous year. This represented the most significant increase in annuity contract premiums over the last 20 years.
If you’re like millions of others considering an annuity, the first step is to choose between qualified and nonqualified annuities. Here’s a look at the similarities and differences to help you make the right decision.
What Are Qualified Annuities?
Qualified annuities are funded with pretax dollars, which can reduce your taxable income and make saving for retirement easier. Your contributions can then grow tax deferred.
To purchase a qualified annuity, you must have earned income. Earned income is money you receive from working for someone else or running your own business. It can include wages, salaries, self-employment income, and tips.
How Are Qualified Annuities Funded?
Qualified annuities are primarily funded with pretax dollars and are subject to IRS contribution limits. Common funding sources for qualified annuities include:
- Traditional individual retirement accounts (IRAs)
- 401(k) plans
- 403(b) plans
- Other types of employer-sponsored accounts
You can also contribute to qualified annuities with Roth IRAs, funded with after-tax dollars.
How Are Qualified Annuities Taxed?
With qualified annuities, the principal balance and appreciation haven’t been taxed. As a result, you pay income taxes at withdrawal. You typically pay regular income taxes on the entire qualified annuity payment.
Are Required Minimum Distributions Required on a Qualified Annuity?
Required minimum distributions (RMDs) are the minimum amounts US tax law requires you to withdraw annually from certain retirement accounts, including qualified annuities. Typically, you must take RMDs from qualified annuities by April 1 of the year after you turn 72—unless you participate in an employer-sponsored plan and are still working.
What Are Nonqualified Annuities?
Nonqualified annuities are funded with after-tax dollars. Anyone can purchase a nonqualified annuity—you don’t need to have earned income.
How Are Nonqualified Annuities Funded?
Unlike a qualified annuity, nonqualified annuities aren’t subject to IRS contribution limits. Because you fund nonqualified annuities with after-tax dollars, you can use various sources, such as:
- Checking accounts
- Investment proceeds
- Inheritances
- Gifts
- Savings accounts
How Are Nonqualified Annuities Taxed?
Because you already paid taxes on the funds you contributed to a nonqualified annuity, the principal isn’t taxed when you withdraw it. You typically only owe taxes on the investment’s earnings, such as interest, capital gains, or dividends. The gains are taxed as ordinary income.
With nonqualified annuities, your investment grows tax-deferred, meaning you only pay taxes once you start receiving payments from the annuity.
Are RMDs Required on a Nonqualified Annuity?
Nonqualified annuities don’t have RMDs. However, once you start taking withdrawals, you receive the taxable portion of your annuity—interest or earnings—first.
Comparing Qualified and Nonqualified Annuities
Both nonqualified and qualified annuities can provide a reliable income stream for the rest of your life. However, they offer different features and functionality.
Here’s a side-by-side comparison of a qualified vs. nonqualified annuity:
|
Qualified Annuity |
Nonqualified Annuity |
|
|
How Is It Funded? |
Pretax Funds or Roth |
After-Tax Funds |
|
When Do You Pay Taxes? |
At Withdrawal |
At Withdrawal |
|
What Taxes Are Owed? |
On Entire Distribution |
On the Earnings or Interest Portion of the Distribution |
|
Are RMDs Required? |
Yes |
No |
|
Are There Contribution Limits? |
Yes |
No |
|
Who Can Purchase One? |
People with Earned Income |
Anyone |
Choosing between Nonqualified and Qualified Annuities
Determining whether to purchase a qualified or nonqualified annuity is a personal decision based on your financial goals, tax situation, and broader retirement strategy. You may be more likely to select one or the other in a few scenarios.
Is a Qualified Annuity Right for You?
You may consider a qualified annuity if:
You Want a Tax Deduction Today
Qualified annuities funded with pretax dollars offer an immediate tax benefit and can reduce your taxable income.
You Participate in an Employer-Sponsored Retirement Plan
Qualified annuities can be valuable additions to your portfolio if you already participate in a 401(k), 403(b), or other qualified plan through your workplace.
You Expect to Be in a Lower Tax Bracket in Retirement
Qualified annuities allow you to defer paying taxes today until retirement, when you may be in a lower tax bracket.
Is a Nonqualified Annuity Right for You?
You may consider a nonqualified annuity if:
You’re a High-Income Earner
If you’ve already maxed out your contributions to tax-advantaged retirement accounts, nonqualified annuities can offer another way to save for retirement. They give you tax-deferred growth on your after-tax contributions.
You Expect to Be in a Higher Tax Bracket in Retirement
The principal balance will be a tax-free income stream since you only pay taxes on the interest or gains.
You Want Maximum Flexibility
Nonqualified annuities generally have fewer restrictions than qualified annuities regarding contribution amounts and RMDs.
Contact Bankers Life to Choose the Right Annuity
Navigating the world of annuities can be overwhelming, especially when you’re trying to make the right decision for your retirement. Whether you’re considering a qualified annuity for tax-deferred growth or a nonqualified annuity for greater flexibility, choosing the option that aligns with your financial goals and plans is essential.
Fortunately, Bankers Life can help. A Banker’s Life representative can provide personalized advice and guidance tailored to your unique situation. Contact us today to explore your options and take the next step toward securing your financial future.
We’re here for you!
Bankers Life is here to help customers with their financial and insurance needs so please visit us at BankersLife.com to learn more.
Insurers and their representatives are not permitted by law to offer tax or legal advice. The general and educational information here supports the sales, marketing or service of insurance policies. Based upon individuals’ particular circumstances and objectives, they should seek specific advice from their own qualified and duly-licensed independent tax or legal advisors.
Bankers Life Securities, Inc., Bankers Life Advisory Services, Inc., and their representatives do not provide legal or tax advice. Each individual should seek specific advice from their own tax or legal advisors.
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.
Bankers Life is the marketing brand of various affiliated companies of CNO Financial Group including, Bankers Life and Casualty Company, Bankers Life Securities, Inc., and Bankers Life Advisory Services, Inc. Non-affiliated insurance products are offered through Bankers Life Securities General Agency, Inc., (dba BL General Insurance Agency, Inc., AK, AL, CA, NV, PA).
Securities and variable annuities offered through Bankers Life Securities, Inc. Member, FINRA/SIPC (dba BL Securities Inc., AL, GA, IA, IL, MI, NV, PA). Advisory products and services offered by Bankers Life Advisory Services, Inc. SEC Registered Investment Adviser (dba BL Advisory Services, Inc., AL, GA, IA, MT, NV, PA).
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