Taxes & Non-Qualified Investments

In simple terms, a non-qualified investment is an investment that does not have any tax benefits.  The two most common investment account types are your checking and savings accounts.  Annuities also represent a common example of non-qualified investments.  They are funded with after-tax dollars, meaning you have already paid taxes on the money before it goes into the annuity. When you take money out, only the earnings are taxable as ordinary income.

There are several tax advantages to having a non-qualified annuity. Not only does it present an additional income stream for when you retire, but the earnings grow tax deferred until withdrawn. They offer longer age limits on contributions. Finally, unlike the qualified investments such as an IRA, there is no Required Minimum Distribution at the age of 72 with Non-Qualified Investments.

One thing to really consider when dealing with a non-qualified investment is how you will receive your proceeds at retirement. You may do so as a lump sum payment, but keep in mind that this could result in a significant tax liability, especially if it moves you into a higher tax bracket. You could also request fixed payments for life or a fixed amount for a certain period of time. The two latter options spread the tax liability over time, because only the earnings are taxed.

At Optimal Wealth Services, we’ll review your options for non-qualified investments and discuss what distribution option is best for your specific needs.

Taxes & Qualified Investments

A qualified investment refers to an investment purchased with pre-tax income, usually in the form of a contribution to a retirement plan. They include Traditional IRAs, Roth IRAs, 401(k) and other employer-sponsored benefit plans.

Contributions to your qualified accounts such as a Traditional IRA, can be fully or partially tax-deductible based on your modified adjusted gross income.  In a traditional 401(k), your employee contributions reduce your income taxes for the year they are made.

Following the December 2019 passage of the SECURE Act, once you reach the age of 72, you are required to withdraw minimum amounts, known as RMDs (“Required Minimum Distributions”) from your qualified account. These distributions are subject to taxation.  Furthermore, if you decide to withdraw any money before the age of 59 ½ (“early withdrawals”), you may be subjected to a 10% penalty PLUS taxes. However, there are exceptions to this rule.

At Optimal Wealth Services, we’ll review your options for qualified investments and discuss which one is best for your specific needs.

Rollover and Conversion Strategies

A Roth conversion refers to moving of assets from a tax-deductible individual retirement account (such as a Traditional IRA or SEP IRA) to a non-deductible Roth IRA. The amount you choose to convert will be taxed as ordinary income which can push you into a higher marginal federal income tax bracket.

One rationale for converting funds to a Roth is that you expect to pay higher federal income tax rates in the future, compared to the income tax rates you’re paying now. What if that’s not the case though?

Most retirees will have lower taxable income in retirement compared to their working years, since they’ll have lower total income in retirement and can use a higher standard deduction once they reach age 65. Under the current tax rate structure, they will most likely pay federal income taxes at a 12% marginal rate or lower in retirement. In this case it’s unlikely that a Roth conversion would help them save income taxes over their lifetime, even if tax rates increase in the future.

At Optimal Wealth Services, we’ll review your income and accounts with you and, if the Roth Conversion is right for you, we’ll assist you with the entire process.