A non-qualified annuity is a flexible tool for building your financial future. You can use it to grow your savings, generate a steady income, and prepare for future expenses. 

Learn what non-qualified annuities are and how they differ from qualified annuities. We'll cover their tax advantages, withdrawal rules, and key benefits to help you decide if they fit your needs.

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What is a non-qualified annuity and how does it work?

A non-qualified annuity is a flexible financial product you fund with after-tax contributions. It offers tax-deferred growth and a potential income stream for retirement or other goals. Most annuities are non-qualified. That simply means they're funded with after-tax dollars and come with different tax rules and flexibility compared to qualified retirement plans.

Non-qualified refers to how these annuities are taxed. Financial advisors often use this category to explain tax benefits. This title — non-qualified — can apply to any annuity type, from fixed or variable to immediate or deferred.

Non-qualified annuities are unique because you fund them with after-tax dollars, so money you've already paid taxes on. This won't give you an upfront tax break, but the annuity will grow tax-free until you withdraw (which is known as tax-deferred growth). 

An appealing feature of a non-qualified annuity is its flexibility. Unlike an IRA or 401(k), which both have yearly caps, this annuity lets you save as much as you want. Because it doesn’t have annual contribution limits, it’s an attractive option for high-income earners looking to save more for retirement.

Non-qualified annuity benefits include:

• Tax-deferred growth potential
• No required minimum distributions (RMDs) at age 73
• Flexible contribution options
• Death benefit protection for beneficiaries

In terms of access to funds, non-qualified annuities offer a unique advantage: Your deposit returns to you tax-free since you've already paid taxes. You’ll only pay on earnings you withdraw from the annuity because the IRS treats it as ordinary income.

Non-qualified annuities are available to anyone and offer flexibility and tax-deferred growth, making them an excellent way to supplement your retirement income.

For successful retirement planning, it’s important to understand how qualified and non-qualified annuities work. Both can help grow your savings, but they differ in how they’re funded, taxed, and structured.

Funding and taxing

With qualified annuities, you use pre-tax dollars, so you don’t pay taxes upfront. But when you withdraw money, the entire amount is taxed as ordinary income. 

For non-qualified annuities, you fund them with after-tax dollars, so you’ve already paid taxes on your contributions. Only the earnings are taxed when you take money out.

Required minimum distributions

Qualified annuities require you to start taking withdrawals by age 73. The IRS sets this rule to ensure the government gets tax revenue from your savings. Non-qualified annuities don’t have RMDs, which gives you more control over when you access your money.

Contribution limits

Qualified annuities have annual limits on how much you can contribute, similar to IRAs or 401(k) accounts. The IRS sets these limits. Non-qualified annuities don’t have these restrictions, so you can save as much as you want.

Flexibility

Non-qualified annuities offer some distinct advantages over qualified annuities when it comes to flexibility. For one, the IRS contribution doesn’t impose the limits that apply to qualified annuities. Plus, you have more control over withdrawals since there's no requirement to begin payouts at age 73. You can also move funds between different types of annuities (like fixed and variable) without facing early withdrawal penalties. 

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Non-qualified annuity tax treatment: Contributions, growth & withdrawals

The tax treatment of a non-qualified annuity occurs in three stages, each with different implications:

1. Funding: You contribute after-tax dollars to the annuity, meaning you don’t receive an immediate tax deduction. 
2. Growth: Your contribution benefits from tax-deferred compounding. During this stage, your money grows without being taxed on capital gains or dividends, unlike in regular investment accounts. 
3. Payout: You pay ordinary income tax on the earnings portion of your withdrawals, while the initial deposit remains tax-free.

Non-qualified annuity taxation example

Say you buy an immediate non-qualified annuity for $100,000 that pays $550 per month for 20 years. Your payments have two parts:

1. You collect $417 as a tax-free return of your initial contribution. 
2. You collect $133, which is taxable as ordinary income since it represents earnings on the contribution. This exclusion ratio of 75.8% ensures that most of your monthly payment isn’t taxable for as long as the principal portion remains unrecovered.

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How to withdraw money from a non-qualified annuity

A non-qualified annuity withdrawal can come with costly fees, so it’s essential to understand the process before taking money from your account. Here are some essential points to keep in mind:

• If you’re younger than 59½, the IRS imposes a 10% penalty on the earnings part of your withdrawal. Insurance companies may apply surrender fees, typically highest during your contract's first 5–7 years. You’ll also owe regular income tax on the earnings, and early surrender reduces your available income in retirement.
• The IRS requires you to withdraw earnings first, so the full amount of each withdrawal is taxable until you’ve exhausted all income in the account. That said, many annuity contracts, such as Gainbridge^®’s FastBreak™, offer flexibility by allowing you to withdraw up to 10% of your contract value annually — without surrender penalties or market value adjustment. 
• You can avoid the IRS's 10% early withdrawal penalty if you withdraw funds due to qualifying events such as permanent disability, loved ones withdrawing after your death, or you use the funds for specific long-term care costs. 
• Early withdrawals can impact your retirement income. For example, if you contribute $100,000 in an annuity expecting monthly retirement payments of $300, withdrawing $30,000 early for unexpected expenses will likely reduce your future monthly payments in retirement. This reduction happens before factoring in surrender charges or penalties.

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