In an annuity, what does the term "qualified" refer to in a tax context?

In a tax context, the term "qualified" refers to an annuity that is purchased with pre-tax dollars. This means that the funds used to buy the annuity come from a retirement account, such as a traditional IRA or a 401(k), where the contributions are not subject to income tax at the time they are made. Because the contributions are made with pre-tax dollars, taxes on the investment gains and distributions are deferred until the money is withdrawn, usually during retirement when the individual may be in a lower tax bracket.

On the other hand, non-qualified annuities are purchased with after-tax dollars, meaning the investments were made with money that has already been taxed. When withdrawals are made from non-qualified annuities, only the earnings are subject to taxation, while the initial investment can be withdrawn tax-free.

Understanding this distinction is crucial for individuals planning their retirement savings strategy, as it affects tax treatment and the growth potential of their investments.