Qualified vs Non Qualified Money: What’s The Difference?

No matter how young you are, it’s never too late to start getting your financial house in order.  As a matter of fact, people who start their retirement planning at an earlier age are more comfortable in their golden years than those who don’t start early.  Since tax season is among us, I thought it would be a good idea to start with understanding the basics. There are two categories you should familiarize yourself with: Qualified Money vs Non Qualified Money.  What exactly is the difference?                                                          Image result for Black Sassy Emoji

Qualified  Money – “Before Tax Dollars”

Qualified Money means that you have not paid taxes on these funds…YET. Anything that is considered qualified money has been approved and is governed by the IRS. You can also use this money as a deduction on your taxes.  The money contributed into your employee savings/retirement plans (e.g. 401K plan, 403B, 457, Traditional IRAs and others), grow tax-deferred, meaning, your money continues to accumulate without having to pay taxes on it.  However, anytime money is withdrawn, you WILL pay taxes at the point of withdrawal. If you withdraw money prior to age 59 1/2, you will not only pay taxes on the amount withdrawn, you will also pay a 10% IRS penalty for withdrawing too early. Now let’s say you leave your money in your qualified account to continue growing. At age 70 1/2 you must start taking out what the IRS calls Required Mandatory Distributions, also known as RMDs.  If your RMDs are not taken out on time, the IRS will penalize you 50% of what you were supposed to withdraw that particular year, in addition to ordinary (regular) tax.

Example:  Client is 70 1/2 and they forgot to withdraw their 10,000 for the current year.  The IRS will penalize the client 5000 (50%) AND you will pay taxes on the full 10,000, not just the 5000!

Non-Qualified Money – “After Tax Dollars”

Non-Qualified Money means that you have already paid taxes on these funds.  With this type of plan, it is not eligible for a tax deduction on your taxes because it’s already been taxed. When the money is withdrawn, it is tax free.  You won’t be taxed twice! Basically, whatever you contribute, will not be taxed, however, the interest you earned on your contributions WILL be taxed. When you think of this type of non-qualified money, think of an employer who provides specialized forms of compensation to key employees of the company.  All employees do NOT receive these incentives, only the employees that are “business critical”.  Some of the main types of specialized forms of compensation are: Split Dollar are Deferred Compensation.  The IRS does NOT have the same rules in place for non-qualified as it does for qualified money.  Roth IRAs, which also fall into this category do NOT require (RMDs) for the lifetime of the policy owner.

Do you have further questions?  Please feel free to respond to the post.

Next week’s feature:  IRAs – Traditional and Roth

Please Note: Each week I will start off with a question from the previous week’s post.  First person to respond, wins a prize.  Prize for 4/16: $10.00 Starbucks gift card.

Changing the lives in our community….one life at a time

 

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