As you near retirement, it's normal to wonder if you'll have enough resources to live the life you've dreamed of. An annuity could give you financial confidence that you'll have what you need for life.
Nonqualified annuities come with tax advantages that could round out your investment portfolio, especially if you've already maxed out your contributions to a 401(k), IRA or other retirement plan.
Here's how nonqualified annuities work and whether one may be a good option for you.
What is an annuity?
What is a nonqualified annuity?
An annuity can be either
With a nonqualified annuity, you've already paid taxes on the money you contributed to the contract. So when you take money out, you're only taxed on any gains—your contribution's appreciation in value. This differs from a qualified annuity, where withdrawals, both principal and any growth, are subject to income tax when you withdraw, since you funded the contract with pre-tax dollars.
Having a variety of investments with different tax timelines is a
Taxation of nonqualified annuities
Nonqualified annuities are exempt from many of the IRS restrictions that come with qualified retirement accounts. Knowing the key features can help you decide if and how this annuity may fit into your retirement savings plan.
You get tax-free withdrawals of the principal
Withdrawals from the principal balance are tax-free. You'll only be taxed on any earnings the account accumulates. Spreading out this tax burden could result in significant tax savings if, for example, you expect to be in a
You won't have an annual contribution limit
A nonqualified annuity doesn't have an annual contribution limit. For example, while a 401(k) is limited to a $23,000 annual contribution in 2024 ($30,500 if you're 50 or older), you can contribute to nonqualified annuities as much as the contract provider allows. Higher annual contributions could be a critical part of your retirement strategy if you're saving later in life and looking to catch up.
You don't have to take required minimum distributions
Some qualified accounts require you to start taking
Nonqualified annuities don't have RMDs. It's possible to set your annuity date for after you turn 73, giving your money more time to potentially accumulate growth.
You'll pay less tax penalties if you make an early withdrawal
In most cases, if you withdraw money from a qualified annuity before age 59½, you face a 10% federal tax penalty (the same as you would for an early withdrawal from most tax-deferred retirement accounts). With a nonqualified account, if you take money out early, you may be subject to the 10% penalty only on the earnings, since you've already paid taxes on your contributions.
- Be advised: Withdrawals are always on an earning-out-first basis.
Taxes & retirement:
Are you prepared?
Are you prepared?
Pros & cons of a nonqualified annuity
A nonqualified annuity has benefits and drawbacks. Consider these as you decide if this annuity can help prolong your income and care for your needs in retirement:
- No contribution limit or RMDs
- Potential for tax-deferred earnings
- No tax when your premiums are returned to you
- Can only contribute after-tax dollars
Considerations before getting a nonqualified annuity
Even after factoring in the taxation of nonqualified annuities, consider these situations to help decide if a nonqualified annuity is right for you:
When a nonqualified annuity could make sense
In most cases, you first want to
Also, if you expect to be in a higher tax bracket in retirement than you are now, it could benefit you to contribute after-tax dollars to a nonqualified annuity during your lower-income-tax-rate years and then pay taxes at the higher rate later only on the earnings when you take distributions.
When a nonqualified annuity may not make sense
In some situations, you may want to pause before committing to a nonqualified annuity. Consider if it would be more tax-efficient for you to reach your contribution (and catch-up) limits with your qualified retirement plans first. You may even want to think about the possibility of using those accounts to purchase a qualified annuity.
Deciding if a nonqualified annuity fits with your plans
Doing the most with what you've been given includes adopting a tax-diverse investment strategy—spreading out the income tax liability on your assets. It can be an ideal option if you've already maxed out your qualified retirement plans and want an additional tax-deferred product option.
Discuss your goals with a