Glossary

Non-qualified annuity

An annuity bought with after-tax money outside an IRA or employer plan; earnings grow tax-deferred, and only the gains are taxed when withdrawn.

Also called: nonqualified annuity, NQ annuity

A non-qualified annuity is funded with money that has already been taxed and is held outside a tax-advantaged retirement plan. Unlike a qualified annuity inside an IRA or 401(k), it has no annual contribution limit and no required minimum distributions during the owner's life, though contracts set their own maximum age for starting income.

The tax treatment follows from your cost basis. Earnings grow tax-deferred. Withdrawals before annuitization are treated as coming from earnings first, so they're taxed as ordinary income until all the gain is out, and gains taken before age 59½ may also face a 10% IRS penalty. If you annuitize, the exclusion ratio splits each payment into a tax-free return of basis and taxable gain. Say, hypothetically, you invested $100,000 and the contract is worth $140,000: the first $40,000 you withdraw is taxable, and the next $100,000 is not.

Heirs don't get a step-up in basis on an inherited non-qualified annuity, so the deferred gain is taxable to the beneficiary. Because gains are taxed as ordinary income rather than at capital gains rates, compare with a taxable brokerage account before buying for tax deferral alone. See how annuities are taxed and what happens to an annuity when you die.

Last reviewed October 4, 2026

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Related terms

Qualified annuity An annuity bought with pre-tax retirement money, such as inside an IRA or 401(k), so withdrawals are taxed as income and minimum distribution rules apply. Exclusion ratio The fraction of each annuity payment treated as a tax-free return of the buyer's own money, found by dividing cost basis by expected total payments. Cost basis For life insurance and annuities, the after-tax money put in (premiums minus tax-free amounts taken out), which sets how much of a payout is taxed. Deferred annuity An annuity that grows tax-deferred for years before income begins, used to build retirement savings or lock in future lifetime payments. Required minimum distribution (RMD) The minimum amount the IRS requires you to withdraw each year from traditional IRAs and most workplace retirement plans once you reach a set age.

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Annuity beneficiaries and inherited annuity options What a beneficiary can do with an inherited annuity: lump sum, spousal continuation, 5-year or stretch payouts for non-qualified, 10-year rule for qualified. What happens to an annuity when you die How death benefits work before and after payouts begin, what beneficiaries receive, how the money is taxed, and which payout options leave nothing behind. Should you put an annuity in an IRA? An IRA already defers tax, so an annuity inside one adds guarantees, not tax savings. When it can make sense, what it costs, and how RMDs and QLACs work. How annuities are taxed Annuity earnings grow tax-deferred and are taxed as ordinary income at payout; rules differ for qualified, non-qualified, early and inherited annuities. What is an annuity and how does it work? An annuity is an insurance contract that trades a sum of money for income, now or later. How the types work, what they cost, and who they suit and don't.