As a retirement savings strategy, annuities provide an ongoing source of income for the life of the recipient using a lump-sum contribution or by making regular payments for a pre-determined time period. Unqualified annuities have the added benefit of accumulating earnings on a tax-free basis. Because of this tax-free earnings aspect, unqualified annuities can only be rolled into a Roth account under certain conditions.
Qualified vs. Unqualified Annuities
Qualified versus unqualified refers to the type of monies used to fund an account in terms of before-tax versus after-tax status. The type of monies used determines how the Internal Revenue Service (IRS) applies taxes on a particular type of account. As qualified annuities use pre-tax dollars, this type of account exists as part of employer retirement plans. Since unqualified annuities use after-tax dollars, a person or business entity can set up an account on his own through an insurance company. While employer retirement plans may also offer Roth accounts as an investment option, funding for employer-sponsored accounts may consist of both pre-tax and after-tax dollars.
The after-tax monies used to fund an unqualified annuity account allow account holders to receive distributions on a tax-free basis. In effect, only interest earnings generated by any contribution amounts made become subject to taxes. When considering qualified annuities, the use of pre-tax dollars allows account holders to deduct contribution amounts from their income taxes. When a qualified annuity matures, any distributions made from the account become subject to taxes, meaning the IRS charges taxes on any contribution amounts made as well as any interest earnings.
Insurance companies invest annuity account monies into mutual funds, bonds and certificates of deposit as a means for generating interest earnings within the accounts. Individual retirement accounts (IRAs) use annuity products to generate income. Funding for Roth IRA accounts use after-tax dollars, which makes Roth IRAs a type of unqualified annuity. The pre-tax dollar funding requirement imposed on traditional IRA accounts makes them the “qualified” version of IRA annuities. Since Roth IRAs use after-tax dollars, someone with an unqualified annuity or even another Roth IRA account can easily rollover monies into another Roth account.
Designated Roth Accounts
With employer-sponsored plans, the types of investment products used to generate earnings may include annuities, bonds, mutual funds or any combination of investment products. Designated Roth accounts may also consist of annuities products. These types of accounts combine the features of qualified employer plans with those found in unqualified investment products that use after-tax dollars. As pre-tax and after-tax dollars fund these accounts, employees can rollover a designated Roth account into another designated Roth account provided it's done through a direct rollover. If, on the other hand, an employee withdraws the account's monies and then deposits it in another designated account within 60 days, only the pre-tax portion can transfer.
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