Annuities✓ Verified · outline & fact-checked · Sep 2026Difficulty 2/5
What is the principal tax difference between a qualified and a nonqualified annuity?
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
A qualified annuity funds a tax-qualified retirement plan such as an IRA or 401(k): contributions are deductible, growth is deferred, and every dollar distributed is taxable because no basis exists. A nonqualified annuity is funded with after-tax money, so each payment is partly a return of basis and partly gain — taxed under the exclusion ratio of IRC Section 72(b). This funding-and-taxation distinction is the central difference.
Why the other options are wrong
- B) Qualified annuity distributions are fully taxable as ordinary income; income tax-free death treatment applies to life insurance proceeds, not annuity payments.
- C) Nonqualified annuities do enjoy tax deferral on growth during accumulation; that deferral is the product's key advantage.
- D) The 10 percent premature-distribution penalty can apply to nonqualified annuities as well when gains are withdrawn before age 59 and a half.
Memory hook
Qualified = the IRS funds it first (pre-tax), then taxes every bit out. Nonqualified = you paid tax in, ratio taxes the rest out.