The term “qualified” refers to the fact that the annuity meets the requirements of the Internal Revenue Service (IRS) for tax-deferred status.
Features of a qualified annuity
1. Tax-deferred growth
2. Guaranteed income
3. Various payment structures
4. Protections for the annuitant
5. Death benefits
Differences between a qualified annuity and a non-qualified annuity
A qualified annuity is funded with pre-tax dollars from a qualified retirement plan or individual retirement account (IRA). The money is not taxed until it is withdrawn from the annuity, at which point it is subject to income tax. On the other hand, a non-qualified annuity is funded after tax has been paid. The annuitant has already paid taxes on the money used to fund the annuity, so the payments from the annuity are partially taxable.
Benefits of a qualified annuity
1. Qualified annuity offers tax-deferred growth.
2. It provides a guaranteed source of income in retirement.
3. It offers protection against market volatility, as the annuitant’s income is not affected by market fluctuations or changes in interest rates.
4. It offers flexibility in terms of payment structure and payout options.
5. It can also offer estate planning benefits, such as the ability to pass assets to beneficiaries outside of probate.
Drawbacks of a qualified annuity
1. A qualified annuity does not give room for a lot of liquidity.
2. Annuity contracts can be complex and difficult to understand, particularly for investors who are not familiar with financial products.
3. Qualified annuities can be expensive, with fees and expenses that can eat into investment returns.
4. While some qualified annuities offer variable payment options based on underlying investments, others may have limited investment options or fixed payment structures.
5. The fixed payment structure of some qualified annuities may not keep pace with inflation over time, which can erode the purchasing power of the annuitant’s income.
Key point
A qualified annuity is money that is not taxed until it is withdrawn from the annuity and then subject to income tax.
Qualified annuities are typically purchased by individuals who are nearing retirement age and are looking for a guaranteed source of income in retirement. The annuity payments can be structured in various ways, such as a fixed payment amount for a set period, or a variable payment amount based on the performance of the underlying investments.
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