Qualified vs Non-Qualified Annuity: How Each Is Taxed
The two ways an annuity can be owned, and what each means for tax on the income, on withdrawals, at 59½, at RMD age and at death — with a computed example and an exclusion-ratio calculator.
A qualified annuity is bought with pre-tax money inside an IRA or workplace retirement plan, so every dollar it pays is taxable income and RMD rules apply. A non-qualified annuity is bought with money you already paid tax on, so each income payment is split: a tax-free return of your premium and a taxable gain (the exclusion ratio, IRC §72(b)). Example (computed): a $100,000 life annuity bought at 65 paying $761 a month is fully taxable if qualified, but only $344 a month (45.2%) is taxable if non-qualified, until the premium is recovered around age 85.
Last updated 2026-11-04. Sources are linked next to each figure and listed at the end.
Qualified vs non-qualified annuity at a glance
| Qualified annuity | Non-qualified annuity | |
|---|---|---|
| Money used to buy it | Pre-tax money inside an IRA, 401(k), 403(b) or other plan (or rolled over from one) | Money you already paid income tax on |
| Growth before payout | Tax-deferred (as everything in the IRA or plan) | Tax-deferred: the gain is not taxed until it comes out (IRC §72) |
| Income payments | Fully taxable as ordinary income, unless you made after-tax contributions to the plan (Pub. 575) | Split by the exclusion ratio: part tax-free return of premium, part taxable (IRC §72(b)) |
| Withdrawals before annuitizing | Fully taxable (no basis) | Gains come out first and are taxable; premium only after all gain is out (IRC §72(e)(2)(B), (e)(3)) |
| 10% additional tax before 59½ | Yes, on the taxable amount, under IRC §72(t) (the IRA / plan rule and its exceptions) | Yes, on the taxable part, under IRC §72(q) (its own exceptions: death, disability, substantially equal periodic payments, an immediate annuity, and others) |
| Required minimum distributions | Yes: the contract sits inside the IRA or plan; annuity payments that meet Treas. Reg. §1.401(a)(9)-6 satisfy them | None during the owner’s life; after the owner dies the contract must pay out under IRC §72(s) (within 5 years if before payments start) |
| Contribution limit | The plan’s or IRA’s own limit | No IRS limit on the premium |
| Where it goes on Form 1040 | Line 4a/4b (IRA) or 5a/5b (pensions and annuities) | Line 5a (gross) / 5b (taxable part) |
| 3.8% net investment income tax | Never: distributions from qualified plans and IRAs are excluded | The taxable part counts as investment income above $200,000 of MAGI ($250,000 joint) (IRS) |
| Exchange for another annuity | A direct transfer or rollover between plans or IRAs | Tax-free under IRC §1035 if done as an exchange |
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How the exclusion ratio works (worked example)
The exclusion ratio is the investment in the contract divided by the expected return, both measured at the annuity starting date (IRC §72(b)(1)). For a life annuity, the expected return is the yearly payment times a life-expectancy multiple from the IRS tables (Treas. Reg. §1.72-9, Table V; Pub. 939). That share of every payment is tax-free until the whole premium has been recovered; after that, every payment is fully taxable (§72(b)(2)). If you die before recovering it, the unrecovered amount is deductible on the final return (§72(b)(3)).
| Step | Amount |
|---|---|
| Monthly payment | $760.53 |
| Yearly payment | $9,126.36 |
| Table V multiple at 65 | 20 |
| Expected return = yearly payment × multiple | $182,527.20 |
| Exclusion ratio = $100,000 ÷ expected return | 54.8% |
| Tax-free part of each monthly payment | $416.67 |
| Taxable part of each monthly payment | $343.86 |
| Premium fully recovered (tax-free part stops) | after 240 payments, about age 85 |
If the same contract were bought with IRA money (qualified), all $760.53 a month would be taxable from the first payment.
Exclusion ratio calculator (non-qualified life annuity)
Single-life annuity, payments monthly, IRS Table V (unisex) multiple at your age. A joint, period-certain or refund contract uses a different expected return; your insurer reports the taxable part on Form 1099-R.
What the difference does to the tax bill (2026, computed)
A single filer aged 65 with $24,000 of Social Security and $28,000 of other IRA withdrawals adds the annuity above. Federal income tax for 2026 from the tax engine:
| Annuity | Taxable annuity income | Federal tax | Tax added by the annuity |
|---|---|---|---|
| None | $0 | $1,369 | — |
| Qualified (bought with IRA money) | $9,126 | $3,391 | $2,022 |
| Non-qualified (bought with after-tax money) | $4,126 | $2,281 | $912 |
The non-qualified annuity adds $912 of tax a year against $2,022 for the qualified one. Part of the gap comes from Social Security: at this income each taxable annuity dollar also makes more of the benefits taxable ($17,357 of benefits taxable with the qualified annuity against $13,107). Remember what the comparison leaves out: the qualified buyer never paid tax on the $100,000 going in; the non-qualified buyer did.
Withdrawals before payments start: gains come out first
Before the annuity starting date, money taken out of a non-qualified deferred annuity is taxed income first: it is taxable to the extent the contract’s cash value exceeds what you paid in, and only then a tax-free return of premium (IRC §72(e)(2)(B) and (e)(3)). A loan against the contract or pledging it counts as a withdrawal. Contracts bought before August 14, 1982 keep an older premium-first rule for that money (Pub. 575). Before 59½, the taxable part also owes a 10% additional tax unless an exception in §72(q)(2) applies, such as death, disability, a series of substantially equal payments or an immediate annuity.
Fixed-period annuities use a simpler ratio
For payments for a fixed number of years, the expected return is just the total of the payments (Treas. Reg. §1.72-5(c)). A $100,000 non-qualified 10-year period-certain annuity paying $1,058.21 a month (modelled at the 10-year Treasury yield) returns $126,985.20, so 78.7% of each payment is tax-free. More on these contracts: fixed-term annuities.
Which should you use?
- Inside an IRA or plan, an annuity adds no further tax deferral — the account already has it. What it adds is guaranteed income, at the cost of fees and liquidity. A deferred income annuity held in an IRA as a QLAC can also postpone part of the RMDs.
- Outside one, a non-qualified deferred annuity gives tax deferral with no contribution limit, but its gains are taxed as ordinary income when they come out (not as capital gains), and heirs get no step-up in basis.
- A woman buying the same $100,000 contract at 70 would get about $791 a month on the same model, with an exclusion ratio of 65.9% — older buyers recover their premium over fewer expected payments.
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Run the free retirement planner →Common questions
What is the difference between a qualified and a non-qualified annuity?
Where the money came from. A qualified annuity is funded with pre-tax money in an IRA or employer plan, so every payment is taxable and RMDs apply. A non-qualified annuity is funded with after-tax money, so part of each payment is a tax-free return of premium (IRC §72(b)).
Are non-qualified annuity withdrawals taxable?
The gain is. Before payments start, withdrawals come from gain first and are taxable as ordinary income until all the gain is out (IRC §72(e)); before 59½ the taxable part can also owe a 10% additional tax (§72(q)).
Do non-qualified annuities have required minimum distributions?
Not while the owner is alive. After the owner dies, the contract must be paid out under IRC §72(s): within 5 years if the owner died before payments began, or at least as fast as the existing schedule if after. A qualified annuity follows the IRA or plan RMD rules.
How do I calculate the exclusion ratio?
Divide what you paid (investment in the contract) by the expected return. For a life annuity the expected return is the yearly payment times the IRS multiple for your age (Table V); for a fixed period it is the total of the payments. At 65 the Table V multiple is 20.
Is annuity income taxed as capital gains?
No. The taxable part of an annuity payment or withdrawal is ordinary income, qualified or not.
Sources
- 26 U.S.C. §72 (annuities: (b) exclusion ratio, (e) amounts not received as annuities, (q) 10% additional tax, (s) death of holder, (t) qualified plans)
- Treas. Reg. §1.72-9 (expected-return multiples, Table V)
- Treas. Reg. §1.72-5 (expected return)
- IRS Publication 939 (general rule for pensions and annuities)
- IRS Publication 575 (pension and annuity income)
- Treas. Reg. §1.401(a)(9)-6 (RMDs from annuity contracts)
- 26 U.S.C. §1035 (tax-free exchanges of annuity contracts)
- IRS: Net Investment Income Tax
- SSA 2022 period life table
- U.S. Treasury daily par yield curve (November 3, 2026)
Payouts and the exclusion ratio are computed by frontend/js/calc/annuity-payout.js (the annuity payout calculator’s engine); the 2026 tax by frontend/js/calc/household-tax-2026.js, the federal engine copy held to POST /api/federal-tax. QuantCalc is calculation software, not tax, legal, insurance or investment advice.
Related
Annuities explained → Fixed-term annuities and MYGAs → Annuity payout calculator → Annuity rates → RMD rules 2026 → 401(k) withdrawal rules →