Non Qualified Investment Accounts Vs. Qualified Accounts
Two distinct categories of retirement accounts exist: qualified and non-qualified. The general concept of both types is to provide tax-deferred accumulation of funds for use during retirement, but certain features of each type of account may make one of them more or less appropriate for your own retirement savings, depending on your individual situation.
The most common types of qualified retirement accounts are IRAs and 401(k)s. IRS guidelines determine eligibility, and affect your deposits and withdrawals from such accounts. These plans allow you to contribute money in a tax-favored manner and proactively save for your retirement. In addition to deferring income taxes on any accumulation within the account, you may also receive tax breaks for the years you make contributions.
The most common types of non-qualified accounts are annuities. These retirement accounts are offered by life insurance companies, and work in much the same way as IRAs and 401(k)s, but without many of the IRS constraints on deposits and withdrawals. You won't get a tax break for money deposited into a non-qualified account, but the other advantages might more than make up for the missing income tax deduction.
Perhaps the most significant difference between qualified and non-qualified accounts is the contribution maximum stipulated by the IRS. In Publication 590, the IRS states that the maximum IRA contribution is the lesser of $5,000 or 100 percent of your taxable income. In the 401(k) Resource Guide, it explains that the maximum salary deferral is $17,000. These limitations do not apply to deposits into non-qualified retirement accounts.
Deposits into qualified accounts result in an income tax deduction for the year in which the contribution was made. That deduction may reduce your taxable income far enough to drop you into a lower tax bracket. Contributions into non-qualified accounts do not generate tax deductions and will not affect your tax rates.
Money in both qualified and non-qualified accounts accumulates tax-deferred until it is withdrawn. Untaxed portions of any withdrawals increase your earnings for the year, and have the potential to raise your income to a higher tax bracket. Since qualified accounts consist entirely of tax-deductible contributions, every dollar withdrawn is taxable. With non-qualified retirement accounts, only the growth is taxable. Once distributions from those accounts exhaust the earnings, any subsequent withdrawals are considered a return of your deposits. Distributions prior to age 59 1/2 from either account type may result in early withdrawal penalties. You can leave money in a non-qualified retirement account for an indefinite period of time, but you must begin withdrawing assets in qualified accounts by age 70 1/2.
Gregory Gambone is senior vice president of a small New Jersey insurance brokerage. His expertise is insurance and employee benefits. He has been writing since 1997. Gambone released his first book, "Financial Planning Basics," in 2007 and continues to work on his next industry publication. He earned a Bachelor of Science in psychology from Fairleigh Dickinson University.