What is the Difference Between Qualified and Nonqualified Annuities?

No matter what stage you are at, retirement planning always seems to be an alphabet soup filled with all kinds of “similar but different” options: 401(k)s, Roth IRAs, and so on. The labels, as defined by the Internal Revenue Service (IRS), often overlap causing even more confusion. When you’re trying to set up an investment portfolio that guarantees your financial future after your last day of work, every little bit of clarity helps. With that in mind, here are three key differences between qualified and nonqualified annuities:
1. Tax Deferment
The primary means by which to distinguish your annuity is whether contributions are made before or after taxes are pulled out of your paycheck. For the most part, if pre-tax dollars are used to fund the account, such as in an employer-created 401(k), the IRS classifies it as “qualified” and will tax disbursements in the future. On the other hand, when you set aside part of your net earnings into an investment vehicle – a money market account or whole life insurance policy with cash value, for instance – you are participating in a “nonqualified” agreement in which taxes have already been paid.
2. Investment and Income Restrictions
Simply put, the IRS sets limits on the amount of qualified annuity contributions which can be made every year. Since 2009, the maximum amount that can be set aside in a 401(k) is $16,500 with an additional “catch-up” amount of $5,500 available to people over 50. Nonqualified plans, because they are made out of after-tax monies, have no ceilings – you can add as much as you can afford to your account, so long as the company you’re doing business with permits it (and most do).
In addition, there are income restrictions on certain types of qualified annuities: if you would like to fund a Roth IRA, you’ll have to earn less than $105,000. Though you may not be affected early in your career, as your earnings grow you’ll be exempt from contributing to an account which might allow another $5,000 investment for your retirement portfolio.
3. Mandatory Withdrawal Dates
Both types of annuities are subject to a 10% penalty if you withdraw from them earlier than six months before your 60th birthday, but there is no point at which you will be required to accept payments on your nonqualified account unless you agree to it. (Some insurance companies, as an example, might require them to begin at age 85.) However, if you have a qualified annuity, you’ll be required to receive the first disbursement no later than six months after your 70th birthday. The IRS uses life expectancy estimates to ensure monies are distributed – and taxed, since they haven’t been yet – to appropriately fund the golden years of retirees.
With all the options available, it can be tough to discern the best course. Be sure to consult with a trusted financial advisor before making any decisions, as they will best understand your goals and current portfolio make-up.

Leave a Reply

Your email address will not be published. Required fields are marked *