How retirement planning is affected by taxes is important to everyone because of the necessity to have income at that point in life and the effects taxation can have. There are key differences between qualified and non-qualified retirement plans. Knowing what these types of plans are and the advantages and disadvantages they provide can prove to be really valuable information
A qualified retirement plan is a tax-deferred account that presents the employer, and individual in some cases, with tax deductions for contributions made into the account. These deductions are applicable to both individuals and employers, up to a certain amount. The requirements, or qualifications, are established by the Employee Retirement Security Act of 1974, also known as ERISA, and the Internal Revenue Code (IRC).
Payments are made with pre-tax dollars, allowing for a greater initial contribution to be made and therefore the possibility of more growth. Most employer-sponsored plans, such as 401(k) and 403(b) plans are considered qualified. In some cases, IRAs may be considered qualified as well, but these are subject to income limitations.
The types of accounts that are generally deemed qualified are those that are employer-sponsored such as the 401(k) and 403(b). It is possible for an IRA to be labeled as qualified as well, if the individual meets the income limitations placed by the IRS. By paying into these types of accounts with pre-tax dollars, more is invested up front and allowed to accumulate growth.
A non-qualified retirement plan is one which does not meet the above stipulations. Investments are not subject to the same favorable tax treatment. In some cases, such as the Roth IRA, payments made into the plan are done with after-tax dollars. Distributions from this type of account are not subject to taxation as long as the owner is above the age of 59.5 and has held the account for more than five years.
Taxation and tax planning are key components to considering which type of account to open. If growth opportunities are deemed to be greatest need, then choosing a qualified account may be appropriate. However, the greater the number of tax-deferred accounts, the higher the taxes when distributions are made.
The upfront tax deductions, in conjunction with the possibility of more return due to increased amounts of money being put into the account may be very advantageous, especially to those in a high tax bracket. Upon a later distribution, it could be that the investor is in a lower tax bracket, thereby extending the tax benefits. This is especially true since capital gains are taxed at a rate of 15 percent.
What types of accounts a person already has in existence and the implications on taxes are very important considerations in determining which type of retirement plan to choose. Although most IRAs are not considered to be qualified plans by the IRS, unless certain income restrictions are met, they could be useful. For instance, the Roth IRA grants an opportunity for tax-free income during retirement. It is important to know the differences between a qualified and non-qualified account and what each brings to the tax table.
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