Non-Qualifying Investment: Definition, Examples, Taxation

What Is a Non-Qualifying Investment?

A non-qualifying investment is an investment that does not qualify for any level of tax-deferred or tax-exempt status. Investments of this sort are made with after-tax money. They are purchased and held in tax-deferred accounts, plans, or trusts. Returns from these investments are taxed on an annual

Understanding Non-Qualifying Investments

Annuities represent a common example of non-qualified investments. Over time, the asset may grow with deferred taxes pending withdrawal. For non-qualified annuities, when they are cashed out and surrendered, the first money to come out of the account is treated as earnings for the account holder for tax purposes. If the account holder also withdraws the money originally invested, known as the cost basis, that portion is not taxed again because those taxes were already paid.

With non-qualifying investments, an investor is typically under no annual restrictions as to the amount they can put towards such assets. This can sometimes offer more flexibility compared with qualifying investment accounts, which usually have maximum amounts that may be contributed, depending on the type of asset.

Employee 401(k) accounts, for example, are limited to an annual maximum contribution. The limit may increase somewhat over the years, as determined by the Internal Revenue Service (IRS). A non-qualifying investment can see any size contribution made over the course of each year according to the account holder’s strategy for saving.

Account holders can also make withdrawals on non-qualifying investments when they want, though they will pay tax on interest and other gains, such as appreciation, that have accrued. There also may still be early withdrawal penalties if the account holder takes cash from certain types of assets before reaching a specific age—typically 59½. Also, the account holder might be required to start making withdrawals from their non-qualifying investment accounts at a certain age, often 70½.

Non-Qualifying Investment Example

Some examples of investments that do not usually qualify for tax-exempt status are antiques, collectibles, jewelry, precious metals, and art. Other investments that may not qualify for any sort of preferential tax treatment are stocks, bonds, REITs (real estate investment trusts), and any other traditional investment that is not bought under a qualifying investment plan or trust.