What Does a Qualified Investment Mean?

Posted Jan 11, 2023

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Are you contributing to a retirement plan with your employer? If so, then you are likely utilizing a qualified investment. Qualified investments include 401(k), 403(b), 457(b), SEP-IRA, and SIMPLE IRA plans. These plans follow IRS rules and restrictions. They also have tax benefits. Keep reading to see what these plans are all about.

Qualified Investments Or Retirement Plans

Many retirement plans are qualified investments. These are plans that are employer-sponsored and adhere to IRS rules and regulations. They also have tax benefits in that they defer the payment of taxes until retirement. 

Employees participate in these plans by contributing pre-tax money directly from payroll. These contributions are a fixed dollar amount or percentage of every check. Many employers have matching contributions where a percentage of the employee’s contribution is matched.

Money in these investments grows tax-deferred, which means employees can save money on taxes while working. Taxes are still eventually owed, though. Once distributions are taken in retirement, taxes must be paid on principal and growth. However, income is usually lower in retirement than in working years, which can result in a lower tax bill.

The IRS does impose restrictions on qualified investment plans. These restrictions come in the form of the following: 

- Annual contributions limits

- Penalties for taking distributions before a certain age

- Required distributions at retirement

Taking distributions before age 59 1/2 can result in penalties as high as 10% plus taxes owed on the amount taken out. There are exceptions when distributions are for death, child support, spousal support, active military, disability, and medical expenses.

Additionally, minimum annual distributions must be taken at age 72. These are called required minimum distributions or RMDs.The annual amount will increase each year based on the RMD calculation.

What Is A Non-Qualified Investment?

Not all retirement accounts are qualified investments. A Roth IRA and Traditional IRA are two retirement accounts that aren’t employer-sponsored. However, an employee can roll over a 401(k) into a Traditional IRA.

Non-qualified accounts have different rules on how much money can go into them. There may still be tax advantages with these accounts. For example, a Roth IRA allows investments to grow tax-free. Once the money is withdrawn in retirement, taxes aren’t owed on the growth.

Non-qualified accounts are funded with after-tax money. Depending on the account type, as money grows in the account, it is taxed according to capital gains rules. 

Other non-qualified accounts include individual or joint accounts, certain trust accounts, UTMA (Uniform Transfer to Minors Act) accounts, and UGMA (Uniform Gift to Minors Act) accounts.

Many employees first take advantage of their employer’s retirement plan (a qualified investment) before turning to other forms of retirement plans. The primary motivation is the tax benefits offered by qualified investments. Of course, there are many ways to invest for retirement. It’s best to speak with a tax specialist when considering different ways to contribute to retirement.

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.

Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.

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