If you’re a parent with elementary school aged children, you’re familiar with the annual science fair project. One such project is the concept of how molecules of water are attracted to each other, and so are molecules of oil, so they quickly separate when mixed. The oil always floats on top of the water because the oil has a lower density than water. No matter how hard you shake or stir the mixture, they will always separate.
Money has similar properties when you attempt to blend non-qualified and qualified dollars, or tax-deferred and tax-free dollars, or pre-tax and post-tax dollars. You can’t combine different types of accounts. The IRS won’t allow them to be mixed, combined, or even accessed at the wrong time without serious penalties.
Non-qualified dollars are those that have already been taxed and can be spent or invested freely. Think of these dollars like your paycheck. Your employer already withheld the taxes and now you can save or spend the rest.
Qualified dollars are those that “qualify” for a federal tax benefit, such as tax-deferred or tax-free growth. But wait! There’s always a catch. When the government gives you any benefit, there are generally some strings attached. In the case of qualified plan dollars, there are a lot of them!
Qualified dollars can be in an individual account, like a tax-deferred Traditional IRA, or a tax-free Roth IRA. They can also be inside of an employer sponsored plan, like a pension, profit-sharing, 401(k), 403(b), 457(b), SIMPLE IRA, SEP-IRA, and many others. Each of these accounts have their own set of rules and restrictions.
Do you have any of these accounts? Are you unclear about the rules regarding your specific accounts and what options you have with each one? Allow us to help you navigate this complex arena. Don’t mix the wrong accounts. Feel free to lean on our experience.
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