What is the main distinction between a qualified and a non-qualified annuity?

The distinction between a qualified and a non-qualified annuity primarily lies in their tax treatment and the source of their funding. Qualified annuities are those that meet the requirements set forth by the IRS for tax-advantaged retirement accounts, such as 401(k) plans or IRAs. The contributions made to qualified annuities are typically made with pre-tax dollars, which allows for tax deferral until withdrawal, meaning the earnings and contributions are tax-deferred while held in the annuity.

In contrast, non-qualified annuities are funded with after-tax dollars. This means that the money used to purchase the annuity has already been taxed at the individual's income tax rate, and thus, only the earnings generated by the investment are tax-deferred until withdrawal. This fundamental difference is crucial for understanding the taxation mechanics associated with each type of annuity, as it determines when taxes are owed and what portion of the withdrawal is subject to taxation.

This clarity on the funding and tax implications helps individuals make informed decisions about their retirement planning and investment strategies.