What Is the Difference Between a Roth IRA & a Non-Qualified Account?

As you explore different ways to save and invest, you want to avoid making an investment choice that could tie up your money when you need it most. A Roth IRA and a non-qualified account are near the opposite ends of the spectrum for such potential restrictions.

Qualified vs. Non-Qualified Accounts

Savings or investment accounts can be broadly divided between qualified and non-qualified accounts. Qualified accounts rate special treatment under the tax rules to provide tax-advantaged savings or growth. Qualified account types include 401(k) accounts, SEP IRAs, and traditional and Roth IRAs. Any account -- such as a bank savings account, mutual fund or brokerage account -- not set up as a qualified account is a non-qualified account. Investment accounts can be of either type. For example, you could have a non-qualified mutual fund or have that same mutual fund as part of your qualified Roth IRA.

Roth IRA Advantages

A Roth IRA is a type of retirement account that can be established by any person with earned income. Unlike a traditional IRA, Roth IRA contributions are not tax-deductible. However, the earnings in a Roth IRA grow tax-free instead of just tax-deferred as in a traditional IRA. This means you can make regular contributions to a Roth IRA during your working years and draw a tax-free income from the account when you retire. If your tax-deductible contributions are limited by your income or your participation in an employer-sponsored retirement plan such as a 401(k), you can still contribute to a Roth IRA.

Roth IRA Disadvantages

The tax rules intend for Roth IRA accounts to be used as retirement savings vehicles. If you want to withdraw money before you are age 59 1/2, you must pay income tax and a 10 percent tax penalty on any earnings withdrawn. Another negative factor is the limited contribution limits to a Roth IRA. If you are under age 50, the maximum you can contribute to all of your IRAs is $5,000 per year ($6,000 once you turn 50). The IRA rules limit what type of investments or securities can be held in a Roth IRA. Stocks, bonds, exchange-traded funds and mutual funds are acceptable, but investments in art, collectibles and precious metals cannot be made with Roth IRA funds.

Flexibility of Non-Qualified Accounts

Non-qualified accounts do not have any inherent tax advantages, but they also do not have tax rule restrictions. You can invest as much or little as you want in a non-qualified account and withdraw money at any time without tax consequences. Use non-qualified accounts for savings or investment goals not associated with your retirement plans or to put large sums of money to work. The major drawback to non-qualified accounts is that earnings and gains become taxable income for the year in which they are earned or realized. Paying taxes reduces the after-tax returns compared with earnings in a Roth IRA.