Qualified vs Non-Qualified Roth IRA Distributions

Roth IRA Definition

A Roth IRA is a type of Individual Retirement Arrangement (IRA) that provides tax advantages for retirement savings.

Investors make contributions to an IRA after already paying income tax on the money, providing a double tax benefit. Withdrawals from the Roth IRA are not taxed as long as they meet certain requirements.

Roth IRAs are very popular with young adults who want to start saving for retirement. The younger you are, the more time your money has to grow.

Also, Roth IRAs do not have required minimum distributions, unlike traditional or rollover IRAs that require minimum distributions starting at age 73.

The two basic distributions a holder can make from a Roth IRA are qualified and non-qualified.

Qualified Distributions

The points below detail the requirements for a qualified Roth IRA distribution:

• Made by a person at least 59.5 years old
• Taken because the Roth IRA owner has become wholly or permanently disabled
• Made by a beneficiary after the Roth IRA owner dies
• Taken as a series of substantially equal periodic payments
  
  

An advantage of a Roth IRA qualified distribution is that all of the money invested into the Roth IRA is tax-free. The withdrawal will not be part of the gross income, and the owner will not owe taxes or penalties on the withdrawal.

Non-Qualified Distributions

A non-qualified distribution, on the other hand, has different characteristics than a qualified distribution:

• Withdrawal is made before the owner reaches the age of 59.5 years
• Withdrawal does not meet the five-year requirement
• Withdrawal does not qualify for an exception
  
  

The exceptions laid out by the IRS are as follows:

• Money withdrawn is intended to buy, build, or rebuild a first home.
• Distribution was used to pay for health insurance premiums while the owner was unemployed.
• Qualified reservist distributions
• Distribution is part of substantially equal periodic payments (SEPPs) over the owner’s life expectancy or joint life expectancies.
• Money withdrawn was used to pay unreimbursed medical expenses that total more than 7.5% of the owner's adjusted gross income.
• Money withdrawn is intended to cover qualified higher education expenses.
• Withdrawal results from a levy of the Roth account by the IRS.
  
  

Non-qualified withdrawals do not have tax-free treatment and can be included in gross income for taxation purposes.

Furthermore, there may be an early distribution penalty and an additional 10% tax on the amount withdrawn if it does not meet certain requirements.

Tax Implications of Qualified and Non-Qualified IRA Distributions

A qualified distribution will not have any tax implications.

On the other hand, a non-qualified distribution may incur different taxes depending on how long you have held your Roth IRA.

If you have held the Roth IRA for under five years, a 10% early withdrawal penalty and further taxation of earnings would be withdrawn.

If you have owned the Roth IRA for over five years and did not meet an exception, there is still an early withdrawal penalty of 10%.

However, there is no additional taxation on the part of the withdrawals made from your Roth IRA if you hold it for more than five years or longer. Keeping your funds in a Roth IRA for the required time allows you to avoid paying taxes on a withdrawal and permits the funds to grow faster.

When Can I Take a Roth IRA Distribution?

Ideally, you should only take Roth IRA distributions upon retirement to maximize your benefits from such retirement savings accounts as growing tax-free income.

However, if you find yourself in need of money before retirement, there are certain situations where the IRS grants exceptions to early withdrawals, as discussed above.

These situations may either cause a tax or a penalty. Thus, it is always best to check whether or not the situation you are in qualifies for an exception.

A financial advisor can help give professional advice and find the best solution for your situation.

The Bottom Line

The rules for qualified and non-qualified distributions from a Roth IRA account are intended to encourage Roth IRA holders to leave their money in the Roth IRA account until retirement.

This will maximize the gains you can get from your savings because, at that point, there would be no taxation of the withdrawals if they are qualified distributions.

It is crucial to understand the difference between qualified and non-qualified Roth IRA distributions, as this can significantly impact the taxes you pay on your retirement savings.

Getting advice from financial professionals can help you know what you are getting into when you initiate a withdrawal from your Roth IRA.

FAQs

1. Who is allowed to take distributions from a Roth IRA account whose owner passes away?

The beneficiary selected by the Roth IRA account's original owner may take distributions from the Roth IRA.

2. Who can qualify as a beneficiary of a Roth IRA?

A beneficiary to a Roth IRA can be a spouse, child, grandchild, or anyone else named by the account’s original owner.

3. What makes Roth IRA ideal for young savers?

Roth IRA is ideal for young savers because the amount contributed to it is taxed before it goes into the account. Thus, when withdrawals are made later in life after earning more, taxes will be levied at withdrawal rather than when money was initially contributed.

4. What proofs are needed to prove a plan holder's disability so that he may qualify for an exception?

The plan holder should provide the financial institution holding his Roth IRA with a letter from a physician that states that they are disabled.

5. What happens if an exception to early distribution does not apply?

If an exception does not apply, there will be an early withdrawal penalty of 10% additional tax on earnings and applicable taxation depending on the total amount withdrawn for non-qualified distributions. This can significantly reduce the overall return on investment in your Roth.