Sold by brokerage firms and insurance companies, an annuity refers to a financial arrangement by an investor with a financial company to provide a steady income over a certain period. The payments are generally received in old age for a specified period, till the principal amount is exhausted or till an investor’s death. There are various types of annuities including qualified and non-qualified annuities. Although both offer investors financial security over a specified period, they have differences.
Qualified Annuity
This is an annuity paid with money that has not been taxed. Because no taxes are paid while saving, a tax-deferred interest credit is issued until an investor withdraws funds. Ordinary income tax is hence paid on the distributions taken. In an instance where an investor withdraws from the annuity before turning 59 ½, an additional 10% federal penalty must be paid. Qualified annuities have limited flexibility and maximum contribution limits.
Non-qualified annuity
These are annuities funded with money that has been taxed hence only a small portion of the withdrawal amount is taxed. They have no minimum withdrawal and contribution limits. In an instance where an investor withdraws the annuity before turning 59 ½, only a 10% federal penalty applies.
Similarities between Qualified and Non-qualified annuity
- Both offer investors financial security over a specified period
- Both are subject to a penalty tax in case the annuities are withdrawn before the age of 59 1/2
Differences between Qualified and Non-qualified annuity
Definition
Qualified annuity refers to an annuity paid with money that has not been taxed. On the other hand, non-qualified annuity refers to annuities funded with money that has been taxed hence only a small portion of the withdrawal amount is taxed.
Terms
While qualified annuities have limited flexibility and maximum contribution limits, non-qualified annuities have no minimum withdrawal and contribution limits.
Taxation
In qualified annuities, payouts are taxed at the same rate as incomes. On the other hand, in non-qualified annuities, only the earnings are taxed and not the principal amount.
Qualified vs. Non-qualified annuity: Comparison Table
Summary of Qualified vs. Non-qualified annuity
Qualified annuity refers to an annuity paid with money that has not been taxed. It has limited flexibility and maximum contribution limits and the payouts are taxed at the same rate as incomes. On the other hand, non-qualified annuity refers to annuities funded with money that has been taxed hence only a small portion of the withdrawal amount is taxed. They have no minimum withdrawal and contribution limits and only the earnings, while the principal amount is not taxed. It is important to differentiate between these two while choosing an investment plan.