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
Tax-deferred plans that also provide favorable tax deductions on contributions to both the individual and employer are known as qualified plans. The Employee Retirement Security Act of 1974 (ERISA) and the Internal Revenue Code (IRC) outline the stipulations, or qualifications, that a plan must meet in order to benefit from these tax provisions.
By paying into the account using pre-tax dollars, there is a possibility for greater growth on the overall account. Typically, eligibility to be considered qualified is given solely to employer-sponsored plans. However, in some cases, if an individual meets certain income stipulations provided by the IRS, they may open a qualified IRA.
Tax-deferred simply means that payments made into the account are done with before tax dollars, therefore requiring that income tax be paid upon withdrawal. This provides a benefit to an individual because a greater amount is deposited and allowed to accumulate interest.
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.
The choice of retirement plan is dependent on planning for taxes. It is imperative to know the difference between a qualified and non-qualified account, and the benefits or drawbacks of each. Typically, most IRAs are non-qualified unless the individual meets certain requirements put forth by the Internal Revenue Service. However, the Roth provides the availability of tax-free income later in life, which could prove advantageous. Also, the number and type of accounts a person has is important.
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