Insurers typically issue non-tax-qualified and tax-qualified annuity products. Though both types of annuities are used for accumulation and retirement purposes, the tax treatment, reporting, and other requirements differ markedly for each:

• Non-tax-qualified annuities are purchased with after-tax dollars. Thus, annuity payments are part non-taxable and part taxable income to the recipient. The insurance company determines the non-taxable portion of each annuity payment using an exclusion ratio based on the annuitant's age and the contract's period certain. If the annuitant dies before recovering his or her investment in the contract, the beneficiary will receive the balance of the remaining payments tax-free until the annuitant's investment in the contract has been recovered. Then, all future payments will befully taxed. (Note: See Unit 4 for additional information about annuity settlement options at the owner's or annuitant's death.)
• Tax-qualified annuities are purchased as funding vehicles for qualified retirement plans, such as an IRA, Keogh plan, 401(k) plan, SEP (Simplified Employee Pension), or other plans. Because the initial payment, any additional contributions and interest earnings are all treated as before-tax dollars, each distribution payment is taxable income to the recipient.

There are considerable variations in the amount of fees charged for annuities, as well as differences in quality among products. Thus, consumers should compare an annuity's costs and quality before making a purchase.

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