Non-qualified annuities are insurance policies that provide you with a guaranteed income option when you retire. These annuities may also allow pre-funding of your retirement savings. Such annuities are referred to as "deferred annuities." A deferred annuity that is non-qualified works very differently from an annuity designed to work inside of a qualified plan, such as an IRA. Required Minimum Distributions are also not required except in limited circumstances.
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You cannot contribute money to a non-qualified annuity on a pretax basis because the policy doesn't meet the rules and regulations of the Employee Retirement Income Security Act. All of the money in the annuity is income tax deferred; however, your distributions are taxed to the extent that you realize an investment gain. Unlike ERISA qualified retirement plans, the IRS does not force you to take money from the plan at any specific age.
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Early Distributions Under Rule 72q
You may elect to make yourself subject to special required minimum distributions from non-qualified annuities through an early withdrawal under IRS rule 72q, which requires that you take a minimum dollar amount from your annuity each year when you make withdrawals prior to age 59 1/2. Withdrawals are made according to your life expectancy. If you fail to take these minimum distribution amounts, the IRS treats the withdrawals as non-qualified withdrawals subject to a 10 percent penalty tax. Regardless of the withdrawal type, you pay ordinary income tax on the distribution.
Inheritance
When you inherit an annuity, you pay income tax on all of the money you receive from the policy. The required distribution is due to the fact that the policy pays a death benefit equal to the account value at death. You may take a lump sum amount equal to the account value or you may take guaranteed lifetime payments from the annuity. Alternatively, you may take temporary payments lasting a set number of years. You cannot stop guaranteed annuity payments once you elect to receive them.
Consideration
You can purchase an annuity inside of a qualified retirement plan, such as an IRA, but this changes the rules governing required minimum distributions. Qualified plan rules require that if you have made pretax contributions to the plan, you must start taking withdrawals from your plan by age 70 1/2. The distributions must be based on your life expectancy.