A qualifying annuity is similar to any other annuity, except it has been approved by the IRS for use within a Qualified Retirement Plan or individual retirement account (IRA). These annuities can come in fixed, indexed, or variable forms, depending on the investment objectives defined by the plan sponsor. Following Employee Retirement Income Security Act (ERISA) guidelines, contributions made into a qualifying annuity are tax-deductible unless the annuity has a Roth feature.
Key Takeaways
- A qualifying annuity is an annuity approved by the IRS for use within an IRA or a qualified retirement plan, functioning much like other types of annuities.
- Qualifying annuities can be variable, fixed, or indexed.
- Early withdrawals from an annuity before age 59½ will incur a 10% penalty.
- Non-qualified annuities, purchased with after-tax dollars, only levy penalties on the earnings.
Understanding How a Qualifying Annuity Works
Qualifying annuities must be part of a qualified plan or IRA to enjoy tax-deductible status. They can serve as the sole vehicle inside the plan or account or be one of the several investment choices offered. Often, these annuities are structured as variable contracts, which can be the only vehicle within a plan, with subaccounts available for participants.
Types of Annuities
Qualified and Non-Qualified
Both qualifying and non-qualified annuities use similar products. However, the tax treatments differ. For non-qualified annuities, first withdrawals are considered earnings and taxed as ordinary income. The original investment, when it is finally withdrawn, goes untaxed. Periodic payments from non-qualified plans are partially considered earning and taxed, while the rest counts as a return on the original investment and is untaxed.
Fixed and Variable
Annuities can generally be structured as fixed or variable. Fixed annuities provide regular, periodic payments to the annuitant. Alternatively, variable annuities allow for larger future payments if the annuity’s investments perform well, but smaller payments if they don’t. While variable annuities offer less predictable cash flows, they come with the potential benefits of higher returns.
Special Considerations
There are numerous other considerations, including sales fees, commissions, and the length of the annuity. Whether qualified or non-qualified, withdrawals before age 59½ must face a 10% penalty. For non-qualified annuities, only earnings would be subject to this penalty since these are purchased with after-tax dollars.
Related Terms: Qualified Retirement Plan, IRA, ERISA, Roth IRA.
References
- Internal Revenue Services. “Annuities-A Brief Description”.
- ERISA. “Types of Retirement Plans”.
- Internal Revenue Service. “Annuiities-A Brief Description”.
