Did you know that qualified annuities carry markedly different contribution, withdrawal, and tax regulations as compared to nonqualified annuities? The differences between both types of annuities are explained here. Read on, so you can make a more informed choice.
Through insurance annuities, insurance companies offer to make regular payments to those who choose to pay them a contribution, known as the premium. In return, you can choose to receive variable or fixed annuities.
Typically, you start to receive payments, after an accumulation phase. During this phase you pay premiums which are invested for growth. After this phase, which can vary in periods depending on a number of factors, begins the annuitization phase, where you receive varied or fixed annuities.
Below, you will find the differences between non-qualified and qualified annuities explained.
Non-qualified annuities
Just like earnings on a life insurance contract are not taxed, so are earnings within an insurance annuity. But this is true, only as long as the money remains in the annuity, which is known as the accumulation phase. When the earnings are withdrawn, they're taxed. Also, it is important to remember, that the IRS levies a 10% penalty charge if you withdraw any earnings before the age of 59½; the regular income tax and contract fees could also be charged.
There are also no limits on the contributions that you can make. In addition to choosing whether you'd like to receive variable or fixed annuities, you can also choose how you wish to contribute during the accumulation phase. You could make a one-time, immediate payment, or you can choose to make equal payments. However, tax payments are applicable on the contributions made. Non-qualified annuities are purchased with your regular money, the same money you would use to purchase any other investment.
Importantly, there are not too many age restrictions on when you can begin to make your annuitization payments. However, many insurance companies may require you to begin at 85, which is a reasonable age; although, this too could differ from one insurance annuity contract to another. As far as taxation is concerned, you will have to pay taxes only on the earnings on each payment.
Qualified annuities
If you choose to invest in qualified annuities, do remember that these are regulated by tax benefits and restrictions like the IRAs and other similar qualified plans. The table that follows at the end offers the differences at a glance, but before that let us help you understand the core benefit that qualified insurance annuities offers you, over an nonqualified annuity
Qualified annuities allows you to use pre-tax contributions, although, there are limits on yearly contributions. As of 2011, the amount was capped at $5,000 for those under 50, and $6,000 for those older. A qualified plan would ensure a phase out of the deductibility at high incomes. IRS regulations also require that variable or fixed annuities begin distributions when you turn 70½, with payouts that satisfy the minimum required distribution (RMD) of qualified plans. Besides, in qualified annuities, a full payout is taxed as an ordinary income would be, since it was funded by pretax contributions.
Transfers or Rollovers into qualified or non-qualified annuities
You could use your qualified annuity to rollover from other pre-tax based qualified plans, like an IRA or 401(k). However, a non-qualified annuity could only be used if you had paid taxes before you rolled out of the plan.
401(k) plans or other similar pension plans could offer lower capital gains taxation for a part of their payments; which makes it beneficial to pay taxes for the portion of the amount being distributed and roll the portion subject to ordinary income rates into qualified annuity.
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