When setting up retirement savings and income streams to prepare for life after work, there are a lot of terms your financial advisor or planner (or anyone else you consult with) might throw your way. One of the things they might talk to you about is whether a retirement fund is counted as a qualified or non-qualified retirement plan.
What does “qualified” or “non-qualified” mean for retirement savings and investments? Which is better for your current and future needs?
Let’s start by taking a look at what these terms mean.
When talking about qualified and non-qualified retirement savings/investment plans, a financial advisor is specifically referencing the tax status of the plan. In one case, the taxes on the money invested have already been paid while the other option comes out of pre-tax income.
A qualified retirement plan is funded using pre-tax income. This allows the person investing in the qualified fund to reduce their taxable income for that year.
For example, for 2022 income tax returns, the IRS states that if an individual made an income over $89,075 (or $178,150 for a married couple filing jointly), they would be in the 24% tax bracket. So, if someone made $90,000 in one year, they could invest $2,000 of that into a qualified retirement fund and drop their taxable income down into the 22% tax bracket.
Going into a lower tax bracket when one is barely in the next bracket isn’t too much of an advantage on its own. Only $925 of that $90,000 salary would have been taxed at the 24% rate in the example above since income in each bracket accrues tax separately from the previous ones—the other $1,075 of the money invested in the qualified plan would have been taxed at a rate of 22% because it would have been in a lower tax bracket.
However, 24% of $925 equals $222 of income tax saved. Then there’s the 22% of the other $1,075 of taxable income—or $236.50 in taxes—saved from the lower tax bracket for a tax savings of $458.50. All the while, money is being put into a fund to help pay for future expenses after retirement.
There are limits on how much you can contribute to a tax-deferred retirement savings plan. For example, the IRS set a limit of $22,500 on “employee elective deferrals” and safe harbor plans in 2023 (Source: IRS.gov). This limit changes from year-to-year—it was $20,500 in 2022 and $19,500 in 2021—so be sure to check with the IRS to see what your maximum deferral limit will be for a given year if you want to maximize contributions.
It should be noted that, with a qualified retirement savings investment, you will have to pay taxes upon collection since taxes were not paid on that income initially. So, you’ll have to deal with more income taxes during retirement.
Non-qualified retirement funds put already-taxed money into an investment to be used at a later date. Because taxes were already paid on the money invested, there will be fewer taxes to pay when the money is withdrawn—i.e., the government will only tax the earnings from the investment’s growth, not the initial contribution amount.
This can help to lessen your tax burden during your retirement years—meaning more of your retirement income will be yours and not go to the IRS.
Additionally, non-qualified funds have fewer restrictions on them than qualified retirement savings plans do. If you hit your maximum tax-deferred retirement plan contribution limit, you could then start putting money into a non-qualified retirement plan to maximize your income when you start collecting on your retirement.
Whether a qualified or non-qualified retirement plan will be more beneficial for you depends on when you’re more likely to benefit most from the tax break—while you’re working and contributing to your retirement fund or during your retirement.
Contributing to a qualified fund reduces your tax burden during your working years, when many people see their highest income levels and, consequently, their highest tax bills. A non-qualified fund, however, frees up more of their funds for use during retirement by reducing the tax burden on withdrawals.
A trusted financial advisor can help you determine which strategy is best for making the most of your financial resources. When speaking with your advisor, it can help to let them know what your plans during retirement will be. For example, do you plan to travel a lot during retirement? If so, your financial advisor can use that information to determine what your retirement income needs will be and how taxes on your income streams would affect them.
By themselves, annuities are non-qualified plans. It is possible, however, to hold a deferred annuity within a qualified plan such as an IRA (Individual Retirement Arrangement). This allows you the option of purchasing an annuity using funds from an existing qualified plan.
For example, if you already have a substantial amount built up in your IRA or 401(k), you could roll these funds into a deferred annuity to provide financial security in your retirement.
The big advantage of having an annuity is that it provides you with predictable income for the entirety of the annuitization phase. So, if you set up an annuity for retirement, you can count on having a steady income stream to help fund your plans. This makes it easier to plan around your future retirement income if you use a fixed annuity that guarantees a specific payment amount.
ELCO Mutual offers both single-premium and flexible-premium deferred annuities, which can be purchased with either qualified or non-qualified funds. ELCO offers a range of annuity products with generous liquidity options.
A single-premium deferred annuity can be a powerful retirement tool because the initial lump-sum payment continues to build compound interest as long as you let it grow. ELCO’s single-premium deferred annuities are available for terms of one to ten years, with higher interest rates available with longer terms.
A flexible-premium deferred annuity allows you to begin building a secure retirement income with a much smaller initial investment. You can choose to make a single payment or series of payments to fit your budget. ELCO’s flexible-premium annuity provides free liquidity options after the first 30 days and unlimited penalty-free withdrawals beginning in year six.
Explore ELCO Mutual’s annuity products and check out our FAQ page for more information.
ELCO Mutual and its representatives do not offer tax or legal advice. Please consult with a certified financial planner or advisor before making any major investments.