When it comes to building a life, everyone has a unique perspective on likes, dislikes, goals, careers, hobbies. We all build a path that we feel is the best way to maximize our time, money, energy to yield the results we feel are most desirable. We tailor our day to day to include the people, places, things that bring us the most joy and satisfaction: our investments should be no different. As income earning individuals, we acknowledge life costs money: each of us should be utilizing the various investment types to appropriately have our money work for us. Depending on our stage in life and our specific goals, there are financial investment accounts designed to hold our assets in ways that are suitable to cater to each facete of our lives. Those may include money for kids, for retirement, for emergencies, for entertainment, for travel, etc. The following will compare qualified and non-qualified accounts and when and how each are beneficial. This is simply a high level overview and does not get into all the details that may sometimes arise or apply to each of these accounts.
A qualified account or more commonly known as a retirement account is designed to accept pre-tax dollars: sheltering them and the earnings from taxation and penalty until after 59 ½ years of age. Throughout your earning years you could be introduced to a few different qualified plans depending on your type of employment. Common types of qualified / retirement account are listed below, from most heavily monitored to least:
- 401k, 457, 403b retirement accounts
- Sep and Simple IRA accounts
- Roth and Traditional IRA accounts
The most complex plans (401k, 457, and 403b) are designed to accept both employee contributions and employer matches. You definitely want those “matches”. That is free money your employer gives you to participate in the plan! 403b plans are offered to employees of tax-exempt organizations: examples being teachers, professors, government employees, nurses and doctors. 457 accounts are also associated with tax exempt organizations and allow employees such as firefighters and police to invest a portion of their earnings to defer taxation. 401k registrations are reserved for corporate employees. All these types of accounts shelter assets until retirement age. These versions of retirement accounts have annual limits that you can contribute up to 23k year. If you are over 50 you can make a “catch up” contribution of 7.5k…bringing your total potential contribution annually to 30.5k. That is a lot of money you can save for retirement and shield from taxes at the same time. These limits often go up every few years as they are indexed for inflation.
The next tier of qualified plans are SEP and SIMPLE IRA accounts. These two types of plans are designed to allow for retirement savings for small business employees and self-employed individuals. A SEP IRA is funded by the employer and a SIMPLE IRA is similar to the accounts mentioned above because it includes both employee and employer matching contributions. The contribution limits on both of these accounts are higher than individual retirement accounts. A SEP IRA account allows an investor to contribute the lesser value: 25% of compensation up to 66k annually. A Simple account allows for contributions up to 16k annually and if you are over 50 you can participate in a “catch up” contributions that allows you to put an additional 3.5k into the plan. The size of the company and the role of the investor determines the eligibility to contribute to either of these types of accounts.
Lastly an income-earning individual can have a Roth or Traditional Individual-Retirement-Account (IRA). These accounts have the lowest annual maximum contribution limits but the most flexibility. They are not associated with a specific employer, can be opened by the investor, and are easier to distribute from, while still subject to taxes and penalties and expected to remain invested until at least 59 ½. The contribution limit on these accounts is $7,000 for 2024 and also have catch up contributions if over 50 years old.
In a world where the long-term goals of an employed individual are to avoid taxes and save for retirement, all the above accounts are built to do just that.
Unlike the above-listed accounts, non-qualified accounts are subject to taxes for the entirety of their existence. Non-qualified accounts are strictly investment vehicles that don’t have the same tax sheltering advantages as the retirement accounts listed above. These accounts can certainly be used to help save for retirement and can be invested much like retirement accounts. Some reasons you may want this type of account is that the assets are more readily available if a need for cash arises. You can withdrawal money from these accounts at any time and don’t have to wait until 59.5 years of age to avoid a penalty. Additionally, the investment options are more diverse: they include margin and alternative options, even the ability to hedge. Some other benefits are that there are no annual contribution limits or income limits like there are with some qualified IRA accounts. There are no required minimum distributions that must be taken from the account, like there are with qualified accounts. These can be great accounts to open and get started when you are already “maxing out” your retirement accounts and are looking for another place to invest and build your assets and need an account that is more liquid and readily available if you need money!
Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.
This information is intended to be educational and is not tailored to the investment needs of any specific investor.