A nonqualified annuity is any annuity not used to fund a tax-advantaged retirement plan or IRA, according to Amerprise. Nonqualified annuities are funded with after-tax dollars. Nonqualified annuity premiums are not tax deductible. Tax treatment is the only difference between qualified and nonqualified annuities.
When a nonqualified annuity is surrendered, the portion of the surrender value generated through interest on the money invested in the annuity is considered income and taxed at regular income tax rates, explains Ameriprise. The portion of the surrender value that represents the original investment in the annuity is not taxed. In the case of a partial surrender, the annuitant must withdraw all of the taxable interest dollars before he can withdraw any of the nontaxable dollars.
When regular annuity payouts are made to the annuitant, part of the payments are considered nontaxable original investment dollars and part of the payments are considered taxable earnings, notes Ameriprise. Any distribution taken from a nonqualified annuity before the annuitant is 59 1/2 is subject to a 10 percent tax penalty. In contrast, contributions to qualified annuities are tax deductible. Both immediate and deferred annuities are available to investors. Immediate annuities are funded with one large lump-sum payment and the annuitant receives regular payments right away. Deferred annuities can be funded at one time or with regular premium payments, but payment is deferred at least until the annuitant retires.