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Qualified vs. Non-Qualified Funds

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Nicole: Hey guys, today we are going to be talking about qualified vs. non-qualified funds. MJ, you’re the expert on this so why don’t you tell us a little bit about it. What is qualified vs. non-qualified?  

MJ: Qualified vs. Non-qualified is the way you are putting your money away, the way you are actually investing. With a qualified account you are not going to be paying tax on it prior to putting that money away into your investment plan. For employer sponsored plans, 403(b), 401(k) plan, you’re putting that money away pre-taxed and that money is allowed to grow pre-taxed and then once you start to withdraw the money, that’s when you pay the tax on it. For a non-qualified plan, it would be somewhat like a cash investment where maybe you have a Brokerage account or an E-Trade account where you get that money, you cash your paycheck, and you put that money into that account, so it’s only taxed on the growth rather than the entire amount. You technically already paid taxes on your principal amount. 

Nicole: Interesting. Are there any advantages or disadvantages to either of them?  

MJ: Oh, there are many…The biggest advantage for a qualified plan is that you’re putting that money away pre-taxed, so you’re writing off part of the money that you are investing to pay tax on it at a later date. If you are close to your income bracket, where you are about to jump from one tax bracket to the next, you might want to put some money away into your 401(k) or 403(b) plan at work to reduce your income and get yourself under the threshold the taxes. But, the disadvantage on the flip side is that, that money is going to grow tax deferred, so that small investment that you put away, say you’re putting money away into your qualified employee plan, say you’re putting away 5 or 6 grand a year. That 5 or 6 grand is not being taxed, however as it grows lets say over the course of a 30 years career, that 5 grand every year for 30 years is going to grow and let say it grows to a half a million or million dollars if you’ve invested properly, well now you’re paying tax on that entire amount of that million dollars, rather than paying tax on small chunks every year and putting the money away post tax.  

Nicole: I hear a lot about distributions, when can I start taking distributions on my qualified or non-qualified funds? 

MJ:  That’s a good question. Let me answer the easy one first, that would be your non-qualified money. There are no restrictions on how you take your non-qualified money, so if you are investing that money, from a financial stand point it’s looked at as cash. We can pull out your principal, you can pull out your gains, but you will be reporting that to the government that you earned money on that investment and you’ve now taken that and put it in your pocket. Qualified plans you do have some restrictions, you cannot pull money out of a qualified plan prior to age 59 ½ without getting a 10% penalty. If you need the money, if there is an immediate need, you can do so but you are going to pay that penalty along with reporting that tax money as income.  

Nicole: So, if I wanted to leave all of the assets in my qualified fund until I’m 90, is that something I would be allowed to do? 

MJ: Actually, it is not. The government mandates that you have to start taking, at 70 1/2, RMD distributions. An RMD is a required minimum distribution and starting at 70 ½ you have a specific percentage and those percentages go up every year from the time you are 70 ½ to the time you are 115. At 115 you will have no more money in that qualified plan and the government will have gotten all of their taxed and you will have withdrawn and now closed out your account.  

Nicole: How does qualified money impact your retirements plans as opposed to non-qualified money. 

MJ: I can answer that with a short story about a client of mine. I have a client named Jane, who has been a client for a number of years, she recently retired and she has the three legs of retirement, which is her Social Security, her pension (which she is lucky to have because a lot of us don’t anymore) and her qualified account. Those are her three ways of getting her money for her retirement. She is now on a fixed income for two of those and has a large asset to reach into if she needs it, but it’s all qualified money. Based on the amount of money that she is getting in she is currently at the highest tax bracket, or the highest income level for her tax bracket. She wanted to go on a trip and unfortunately the only way for her to do that was to get money out of her qualified account. Which if you need it, you need it but now she is having to pay more taxes because she’s having to grab out of that qualified account. With proper tax planning you could avoid issues like that knowing that you’ll live on that money and you want to have free reign to put it in your pocket and enjoy it when you retire. 

Nicole: if you guys would like any further information you can comment in the comment section below and our contact information is included at the end of this video.

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