Understanding non qualified annuity taxation is essential for retirees and pre-retirees seeking predictable income, principal protection, and tax-efficient growth. A non qualified annuity is funded with after-tax money—meaning you paid taxes on the contributions before investing. Because of this, the IRS only taxes the growth inside the annuity, not your original premium. This makes non qualified annuities one of the few retirement vehicles that combine tax deferral, flexible income options, and guaranteed performance without being tied to a qualified retirement plan.

At Diversified Insurance Brokers, we help retirees compare how different annuities are taxed so they can build smarter retirement income strategies. Whether you’re comparing annuity growth alongside accounts such as IRAs or learning how annuity interest is credited (similar to what’s explained in how annuities earn interest), understanding your tax treatment is one of the most important steps in your planning.

What Is a Non Qualified Annuity?

A non qualified annuity is an annuity contract purchased with personal, after-tax money. It is not tied to a retirement plan such as a 401k, IRA, or 403b. Because after-tax dollars were used, the IRS considers your premium to be your “cost basis,” and you will never pay taxes on that portion again. Taxation applies only to the interest and growth earned inside the contract.

Many retirees choose non qualified annuities when they want additional tax-deferred growth but have already maxed out qualified plan contributions. While qualified annuities require taxable RMDs, non qualified annuities do not—making them a flexible retirement income tool, especially when paired with tax-sensitive assets such as brokerage accounts, pensions, or lifetime income strategies explained in how pensions work.

How Non Qualified Annuity Growth Is Taxed

Non qualified annuities grow tax-deferred. The interest, index credits, or fixed earnings accumulate without generating current-year taxes. You are only taxed when you withdraw from the annuity, and taxation follows the IRS “LIFO” rule—last in, first out. This means gains are withdrawn first and taxed as ordinary income. After all gains have been withdrawn, subsequent withdrawals are considered return of premium and are not taxable.

This is different from taxable brokerage accounts where interest, dividends, and capital gains generate yearly tax liabilities. For retirees looking to reduce annual taxes while still earning predictable returns, non qualified annuities provide a stable and tax-efficient foundation.

Taxation of Partial Withdrawals

Any time you take a partial withdrawal from a non qualified annuity, the IRS requires that gains come out first. Those gains are taxed as ordinary income, not capital gains. Once all accumulated gain has been withdrawn, remaining withdrawals are tax-free return of basis. This structure allows retirees to choose how much taxable income they generate each year, often paired with Social Security strategies or other income planning outlined in how a 403b works.

Taxation of Lifetime Income Payments

Lifetime income payments from a non qualified annuity receive special tax treatment through an “exclusion ratio.” This means each income payment is partly gain (taxable) and partly return of principal (non-taxable). The IRS calculates the taxable percentage based on your age, your annuity’s value, and the expected payout period.

This blended taxation is one of the biggest advantages of non qualified annuities. Unlike qualified annuities—where every dollar of income is taxable—non qualified lifetime income payments can significantly lower your tax burden in retirement.

Do Non Qualified Annuities Have RMDs?

No. Non qualified annuities do not have Required Minimum Distributions. You control when and how you withdraw your money unless you activate lifetime income, which creates its own payment schedule. This flexibility allows retirees to build balanced income plans with other accounts such as brokerage assets, Roth accounts, and qualified plans.

For individuals transitioning from employer plans into annuities, it may help to review transfer guidelines such as how to transfer a 401k to an annuity or how to transfer an IRA to an annuity—even though those transfers involve qualified funds, the structural comparison is useful.

How Death Benefits Are Taxed

When a beneficiary inherits a non qualified annuity, taxes apply only to gains—not the original premium. However, the payout options available depend on whether the deceased had begun receiving payments. Beneficiaries may be able to take a lump sum, stretch payments over five years, or elect lifetime income, depending on the annuity terms.

The tax rules for inherited annuities differ from inherited retirement accounts such as those described in how inherited IRAs work. Non qualified annuities do not fall under the SECURE Act, so the distribution timelines and tax rules are more flexible.

Using a Non Qualified Annuity for Tax-Efficient Retirement Planning

Non qualified annuities can soften tax impact by reducing reliance on fully taxable withdrawals from accounts such as 401ks and IRAs. Retirees often use them to create blended income—mixing tax-free returns of basis, partially taxable lifetime income payments, and tax-deferred growth. Because there are no RMDs, retirees can delay withdrawals until needed, allowing gains to continue compounding.

For individuals who want stable, predictable returns without triggering annual taxes—especially in years when market volatility is high—non qualified annuities provide a powerful complement to traditional retirement plans.

Lifetime Income Calculator

Use our calculator to see how much guaranteed income a non qualified annuity may provide.

💡 Note: The calculator accepts premiums up to $2,000,000. Larger amounts scale proportionally.

Related Pages

• How Do Annuities Earn Interest?
• Do Annuities Have Fees?
• What Is a Deferred Annuity?
• What Is an Immediate Annuity?
• How Does a Pension Work?