What’s a qualified distribution from a Roth IRA?
If you take a distribution from a Roth IRA, it may be considered a qualified distribution or non-qualified distribution. Find out the requirements of a qualified distribution from a Roth IRA.
Roth IRAs are a popular retirement account option for retirement savers looking to take tax-free distributions in retirement. They also allow retirement savers to access retirement savings at any-time tax-free if they meet the requirements for qualified distributions.
A qualified distribution is a tax and penalty-free distribution from a Roth IRA that meets specific conditions set by the IRS. Any withdrawals from a Roth IRA are considered qualified distributions if you are age 59 ½ or older, and the Roth IRA is at least five years old. A distribution from a Roth IRA may also be considered qualified if you suffer from a permanent disability or if you withdraw up to $10,000 to purchase your first-time home.
Requirements to make a qualified distribution
Qualified distributions only relate to investment earnings in a Roth IRA and not the retirement contributions. Since you pay taxes upfront on Roth IRA contributions, you won’t pay taxes again when you withdraw the money.
To take a qualified distribution, you must meet the following requirements:
To take a qualified distribution, you have must have held the Roth IRA account for at least five years since the first contribution. If you made the first contribution in 2020, the clock starts counting from January 1, regardless of the actual date when you made the contribution.
Age 59 ½
A Roth IRA distribution is considered qualified if it is made when you are age 59 ½ or older. However, if you are below age 59 ½, you will owe an early withdrawal penalty and ordinary income taxes.
An important note is that the 5-year rule may go beyond age 59 ½. If you are 60 but the Roth IRA is less than five years old, any withdrawals taken from the account will not be considered as qualified distributions.
A distribution from a Roth IRA may be considered qualified if you become permanently disabled or die. You can also take a qualified distribution of up to $10,000 if you are using the distribution to purchase a first-time home. A qualified distribution includes withdrawals taken as a series of substantially equal periodic payments.
What a non-qualified distribution from a Roth IRA?
A non-qualified distribution refers to any withdrawals from a Roth IRA that do not meet the prerequisite of a qualified distribution. It occurs when you take a distribution from a Roth IRA that is less than 5 years old, or you are below age 59 ½ at the time of withdrawal. If the distribution does not meet these requirements, you will owe income tax and a penalty for early withdrawal.
However, there are certain circumstances when you may qualify for a penalty exemption. One of these circumstances is when you take a distribution to buy or build your first-time home. You will also be exempted if you take a distribution to cover unreimbursed medical expenses, pay higher education expenses, or settle an IRS level of your Roth IRA account.
These exemptions allow retirement savers to access their retirement savings penalty-free to meet certain expenses. Although you won't pay an early withdrawal penalty on the distribution, you will still owe ordinary income tax
Withdrawing money from a Roth IRA
If you have a Roth IRA, you can withdraw the contributions made to the account at any time tax and penalty-free. Since a Roth IRA is funded with post-tax dollars, it means taxes have already been taken out from the money, and you won’t pay further taxes when you withdraw the money. There is no limit on how much you can withdraw from the Roth IRA.
The rules for Roth IRA distributions apply to investment earnings generated from Roth IRA investments. These earnings are not subject to taxes or included in the gross income. Rather, the earnings grow tax-deferred over the years, and you can withdraw these earnings tax-free if you meet qualified distribution requirements.
However, if the distribution is not qualified, the amount withdrawn will be considered an income for tax purposes, and you will owe ordinary income taxes and a 10% penalty for early withdrawal.
When should you take a Roth IRA distribution?
The ideal time to take Roth IRA distributions is when you retire. You should keep the money intact to allow it to grow through compounding until when you are ready to start taking distributions. Once you are above 59 ½ and the Roth IRA account is at least five years old, you can take tax-free distributions from the Roth IRA to meet your expenses in retirement.
However, if you have a financial emergency or hardship, and you don’t have an alternative source of funds, you may consider tapping into your Roth IRA. You should determine the tax implications of the withdrawal, and how it will impact your retirement savings. If you are using the funds to pay for medical expenses or education expenses, you may be exempted from the 10% early distribution penalty.
If you take a distribution from a Roth IRA before retirement, you could miss out on years of tax-free growth, and the distribution could eat into your retirement nest egg. Also, since the non-qualified distribution is considered an income, it could impact your eligibility to contribute to a Roth IRA. The distribution could push your modified adjusted gross income above the IRS income limits for Roth IRA.