What Is a Nonqualified Variable Annuity?

Use annuities to guarantee an income in retirement.

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An annuity is a long-term savings product sold by insurance companies. You make deposits whenever you wish and pay no tax on your investment returns until you make withdrawals or receive a series of regular payments. Annuities can be deferred or immediate. An annuity you hold during the accumulation phase is called a deferred annuity. An annuity you use to generate a series of payments is called an immediate annuity.

Nonqualified Annuity

A qualified annuity is one you purchase through a pension plan at work. You contribute pretax dollars, meaning the portion of your income you put in is not subject to income tax. You earn tax-deferred investment returns; withdrawals at retirement are fully taxable. A nonqualified annuity is one in which you contribute after-tax dollars; your contributions are not tax-deductible. You still earn tax-deferred investment returns and pay no tax on the portion of your withdrawals made up of contributions. You only pay tax on the portion of your withdrawals made up of investment returns.

Variable Annuity

When you wish to accumulate money in an annuity, you typically have two investment choices. A fixed annuity provides long-term guaranteed interest returns. A variable annuity offers investments where the performance is tied to various stock, bond and money market funds. You generally choose variable annuities for the potential long-term higher returns of the markets; however, returns are volatile, and can result in losses in a bad economy.


Since annuities have no contribution limits, you can use them once your 401(k) and IRA options are maximized to generate additional tax-deferred growth on your investments. Variable annuities are not typically used inside a pension plan at work, but rather in nonqualified situations where the focus is placed on earning more tax-free investment returns.

No FDIC Protection

Annuities offer no FDIC protection; however, you can receive protection under your home state’s life and health guarantee association. The annuity protection limits in most states is $100,000, well below the protection of $250,000 afforded by the FDIC to bank savings accounts and CDs.

Fees and Charges

Annuities usually come with many fees, which can erode your tax-deferral advantages. Fees can include administration fees, investment management fees and agent commissions. You may also pay a surrender charge if you withdraw your money too early.

Penalty Tax

If you make a withdrawal before you turn age 59½, the IRS charges you a 10-percent penalty tax on any amount that must be included in taxable income. This is in addition to any regular tax you must pay on the withdrawal. You do not have to pay the penalty tax if you are disabled of if you receive withdrawals through a series of regular payments made for five years or to age 59½, whichever is longer.