All money spends the same, but not all money is taxed the same. "Tax qualified" money refers to cash you invest put into retirement accounts that carry some sort of tax benefit. In most cases, the money you put in is tax deferred and it grows tax deferred until you pull it out. In some special accounts, you pay taxes on the money you put in, but that's it -- it grows tax-free and you can pull it out and spend it tax free later on.
Tax-qualified money simply refers to money that's put into tax-qualfied accounts -- it's not the money that's special; it's the account. Congress authorized tax qualified accounts to encourage retirement savings. They do this by offering tax breaks of various kinds to savers. The Employee Retirement Income Security Act of 1974 -- ERISA -- put in place the framework for tax-qualified retirement plans. ERISA is the umbrella law covering the rules and regulations of all types of tax-qualified retirement plans.
Types of Accounts
Employers must set up certain kinds of accounts for you, such as 401(k)s and SEP-IRAs. You can set up certain accounts, such as traditional or Roth IRAs, for yourself, and if you're self-employed, special rules apply: you can set up an employer type of qualified plan for yourself with a single participant. For most plan types, the money deposited into a qualified plan is deductible from current income, meaning that you don't pay income taxes on the money when you put it into the plan. The earnings in these plans grow tax-deferred until withdrawals are made. Roth IRAs are the exception: You pay tax on the money in the year you contribute it, but then the earnings grow tax-free.
Restrictions on Qualified Money
Most qualified accounts let you invest money tax deferred, then let it grow tax deferred, until you take it out after you reach age 59 1/2. To prevent the early withdrawal of qualified money, the tax rules require that you pay tax on the money as well as a 10% penalty if you take out your money before age 59 1/2. Again, the Roth IRA is something of an exception: The contributions but not the earnings can be withdrawn tax -free from a Roth IRA, because the contributions have already been taxed.
Annuity products from insurance companies provide tax-deferred earnings but are not tax-qualified accounts. Annuities are not one of the plans or types of accounts covered by the ERISA rules. Like qualified earnings, if an annuity owner withdraws earnings before age 59 1/2, she must pay taxes and a penalty on the earnings. In contrast to qualified plans, there is no limit on how much money an individual can invest in an annuity. It is possible to use qualified IRA money to purchase an annuity. The annuity would then be qualified money, but the qualification is due to the IRA designation, not the annuity wrapper.
- U.S. Senate: Summary of the Employee Retirement Income Security Act (ERISA)
- Guide to Longterm Care: Qualified vs Non-Qualified Money
- Lawyers.com: Retirement Benefits for Employees
- nysscpa.org: Early Retirement: IRS-Approved Options for Early Withdrawals
- Prudential: Tax Strategies: Tax-Deferred Annuities
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