Oftentimes, you hear terms qualified and non qualified annuity used in insurance. You may wonder why one is qualified while the other one is not. Well, in this article, we deeply dive into what a non qualified annuity is.
What is Non Qualified Annuity?
The term “non qualified” is about the applicability of income tax. As the name suggests, a non qualified annuity does not qualify for income taxes. The main reason is that this annuity was funded with after-tax dollars. By after-tax dollars, it means it is an annuity you funded with the disposal income you were left with after paying all your income tax obligations.
Non Qualified Annuity Withdrawals
You get a certain flexibility over withdrawals with a non qualified annuity. This flexibility comes from exemptions of this kind of annuity from Required Minimum Distributions (RMDs). However, knowing that some tax implications will be effected upon withdrawal before a certain age is essential.
Non Qualified Annuity Withdrawals Before 59 ½ Years
Well, there are two reasons why you fund a non qualified annuity. One of these reasons is its tax exemption benefit. The second is to establish a guaranteed steady income during your retirement.
When you fund an annuity, this is not a matter in which only you and your insurer share a direct interest. Astonishingly, even authorities become a stakeholder with direct interest whenever you fund your annuity with after-tax disposable income.
The core role of authority is to discourage you from making early withdrawals. When authorities discourage you from making early withdrawals from your annuity, they protect your financial planning for later years of retirement.
When you withdraw money from your annuity before attaining 59 ½ years, this is called early withdrawal. According to the age of 59½ rule, such early withdrawal suffers a 10% penalty. The 10% penalty might not sound like a substantial figure, especially if your payout is not as high. However, if your withdrawal payout is $10,000, a $1,000 penalty is quite a large figure to lose.
Non Qualified Annuity Beneficiary Options
You and I are likely to buy an annuity with the hope of living a long and healthy life to our retirement years and beyond. However, these are just our desires; reality is a different ball game. Due to the legal penalties discouraging annuitants from making early withdrawals, some are not lucky enough to make a single withdrawal because of a sudden demise.
In case of a sudden demise of an annuitant, their annuity distributions are passed over to their named beneficiary. Below are some payout options that a beneficiary who has inherited an annuity can get:
1. Fixed period payout: The beneficiary could get a predetermined income for a fixed period. This period could be 10 years, 20 years or any other agreed timeframe. This type of beneficiary payout option helps them to continue earning a steady income that the annuitant would otherwise earn if they were alive.
2. Lump sum payout: In another scenario, the insurance company may agree to pay the annuitant’s beneficiary a lump sum. In this case, the interest and principal are given to the annuitants in one go with no future repeated payouts.
3. Spousal continuation payout: Some annuitants may have joint contracts with their spouses. If an annuitant dies, the spouses continue to receive the benefits that would have been given to the deceased individual.
Advantages of Non Qualified Annuity
1. Payouts are exempted from income tax: the distribution payout that annuitant receives from their non qualified annuity is free from income tax. This is because, by default, a non qualified annuity is funded with an already taxed income. It would be double taxation to impose yet another income tax on the payout of non qualified annuities.
2. No contribution limit: Unlike a qualified annuity, there is no cap beyond which one cannot invest annually. This gives an annuitant a room for scaling their annuity as much as they would wish. There is no contribution limit because an individual funding a non qualified annuity has probably maxed out other retirement plans available.
3. Not subjected to RMDs: A non qualified annuity gives annuitants flexibility of when to start receiving their payout distributions. Even though some penalties may apply in case of early withdrawal, annuitants can save themselves from unprecedented financial hardships using their non qualified annuity distributions.
Disadvantages of Non Qualified Annuity
1. Prone to inflation risk: annuities are not the ideal retirement plan to protect you from the wrath of inflation. In the case of hyperinflation, the purchasing power of your steady income keeps on dwindling. If inflation remains high, you may struggle financially during retirement because your annuity earnings have low economic value.
Getting a non qualified annuity can be a good and scalable saving plan if you have maxed out other available retirement plans like IRAs and 401(K). Since you are not limited on how much you can contribute, you can save as much as you can according to your potential.
The scalability of the growth of your annuity is thus under your full control. Considering the RMDs and income tax exceptions, you can fully fledge most financial benefits of an annuity.