# Qualified Annuity: Meaning and Overview

## What Is a Qualified Annuity?

A qualified annuity is a retirement savings plan that is [funded with pre-tax dollars](https://www.investopedia.com/terms/p/pretaxcontribution.asp). A non-qualified annuity is funded with post-tax dollars.

Contributions to qualified [annuities](https://www.investopedia.com/terms/a/annuity.asp) are deducted from an investor's gross income and, along with earnings in the plan, grow tax-free. Neither contributions nor earnings are subject to federal taxes until retirement, when you make a withdrawal.

### Key Takeaways

*   Contributions to a qualified annuity are made with pre-tax dollars. There is an immediate tax benefit.  
    
*   Contributions to a non-qualified annuity are in post-tax dollars: taxes on the contributions have already been paid. There is no immediate tax benefit.  
    
*   "Qualified" and "non-qualified" are Internal Revenue Service (IRS) terms.

## Understanding Qualified Annuities

A deposit into a qualified annuity is made without taxes being withheld. That effectively reduces the investor's income, and taxes owed, for that year. No [taxes](https://www.investopedia.com/articles/pf/07/tax_prep.asp) will be owed on the money that accrues in the qualified account year after year as long as no withdrawals are made.

Taxes on both the investor's contribution and the investment gains that have accrued will be owed after the investor retires and begins taking an annuity or any withdrawal from the account.

While distributions (withdrawals) from a qualified annuity are taxed as ordinary income, distributions from a non-qualified annuity are not subject to any income tax on the contributions, because the plan was funded with after-tax dollars. With a non-qualified annuity, taxes may be owed on the investment [gains](https://www.investopedia.com/terms/g/gain.asp).

Each comes with its own pros and cons. The non-qualified plan offers the prospect of tax-free income during retirement. However, the qualified plan offers immediate [tax savings](https://www.investopedia.com/articles/personal-finance/032116/top-6-strategies-protect-your-income-taxes.asp) and a smaller hit on take-home pay during the person's working years.

> **Important**
>
> No taxes are owed on money that accrues in a qualified account as long as no withdrawals are made.

## Types of Qualified Annuities

Qualified annuities are often set up by employers as part of a company-sponsored retirement plan. Variations include the [defined benefit (pension) plan](https://www.investopedia.com/terms/d/definedbenefitpensionplan.asp), the [401(k)](https://www.investopedia.com/terms/1/401kplan.asp), the [403(b)](https://www.investopedia.com/terms/1/403bplan.asp), and the [individual retirement account (IRA)](https://www.investopedia.com/terms/i/ira.asp).

*   The defined benefit plan is a savings vehicle that commits the company to a specific payment, whether in a lump sum or in monthly installments, based on the employee's earnings history.
*   A 401(k) is set up by a for-profit company to reward its employees. The [SECURE Act of 2019](https://www.investopedia.com/secure-act-4688468) now allows [annuities to be included in 401(k) plans](https://www.investopedia.com/401k-annuity-strategy-11756824).
*   The 403(b) is available primarily to teachers and some other public employees as well as workers at tax-exempt organizations.
*   The IRA is the familiar savings plan that allows a pre-tax or [Roth](https://www.investopedia.com/terms/r/rothira.asp) contribution up to a yearly limit.

An annuity can be qualified if it meets certain [IRS](https://www.investopedia.com/articles/personal-finance/102814/most-helpful-tools-irsgov-website.asp) criteria and follows its regulatory guidelines. Generally, an annuity that is not used to fund a [tax-advantaged](https://www.investopedia.com/terms/t/tax-advantaged.asp) retirement plan is a non-qualified annuity.

### Other IRS Rules on Annuities

Non-qualified annuities purchased after Aug. 13, 1982, are taxed under a "last-in-first-out" protocol. This means that the first withdrawals made by the investor will be taken from accrued interest, which will be taxed as ordinary income. Once that interest has been fully taxed, the remaining principal or premium will be free of taxes. All of the rules governing qualified annuities are covered in IRS [Publication 575](https://www.investopedia.com/terms/i/irs-pub-575.asp): Pension and Annuity Income.

## What's the Difference Between a Qualified Annuity and a Non-Qualified Annuity?

Annuities can be purchased using either pre-tax or after-tax dollars. A non-qualified annuity is one that has been purchased with after-tax dollars. A qualified annuity is one that has been purchased with pre-tax dollars. Other qualified plans include 401(k) plans and 403(b) plans. [Only the earnings of a non-qualified annuity are taxed](https://www.investopedia.com/ask/answers/082715/how-are-nonqualified-variable-annuities-taxed.asp) at the time of withdrawal, not the contributions, as they were funded with after-tax dollars.

## What's the Difference Between a Fixed Annuity and a Variable Annuity?

Annuities are generally structured as either fixed or variable instruments. [Fixed annuities](https://www.investopedia.com/terms/f/fixedannuity.asp) provide regular periodic payments to the [annuitant](https://www.investopedia.com/terms/a/annuitant.asp) and are often used in retirement planning. [Variable annuities](https://www.investopedia.com/terms/v/variableannuity.asp) allow the owner to receive larger future payments if investments of the annuity fund do well and smaller payments if its investments do poorly. This provides for less stable cash flow than a fixed annuity but allows the annuitant to reap the benefits of strong returns from their fund's investments.

## What's the Difference Between an IRA and an Annuity?

Both an [individual retirement account (IRA) and an annuity](https://www.investopedia.com/ask/answers/071614/whats-difference-between-individual-retirement-account-ira-and-annuity.asp) can be classified as a qualified account by the IRS, granting certain tax benefits. An IRA accumulates value over time and is then drawn down in retirement. An annuity instead converts a lump sum or series of payments into a guaranteed income stream in retirement, typically [for the rest of the annuitant's life](https://www.investopedia.com/terms/s/single-life-payout.asp), unless there are [death benefits](https://www.investopedia.com/terms/d/deathbenefit.asp).

## The Bottom Line

A qualified annuity, as defined by the IRS, is funded with pre-tax dollars, which gives an immediate tax benefit to the investor. Contributions to a non-qualified plan, on the other hand, are made with after-tax dollars. This means that taxes are postponed until withdrawals are made during retirement.

> **Article Sources**
>
> 1.  Congress.gov. "[H.R.1994 - Setting Every Community Up for Retirement Enhancement Act of 2019](https://www.congress.gov/bill/116th-congress/house-bill/1994/text)."
>     
> 2.  Internal Revenue Service. "[Issue Snapshot - 403(b) Plans - Catch-Up Contributions](https://www.irs.gov/retirement-plans/403b-plans-catch-up-contributions)."
>     
> 3.  Internal Revenue Service. "[Publication 575 (2021), Pension and Annuity Income](https://www.irs.gov/publications/p575#en_US_2019_publink1000226803)."
>     
> 4.  Annuity.org. "[Qualified vs. Non-Qualified Annuities](https://www.annuity.org/annuities/taxation/qualified-vs-nonqualified/)."