Roth IRA Distributions: Qualified vs Non-Qualified
What Is a Roth IRA?
A Roth IRA is a retirement account that differs from a traditional IRA in a few key ways. Contributions to a Roth IRA are made with after-tax dollars, meaning you do not get an immediate tax break the way you would with a traditional IRA contribution. However, qualified distributions from a Roth IRA are 100% tax-free. That’s a big advantage in retirement, when you may be taxed on your withdrawals from a traditional IRA. Additionally, you can contribute more to a Roth IRA than you can to a traditional IRA. Annual Roth IRA contribution limits are much higher than those of traditional IRAs. And unlike a 401(k) or other workplace retirement plans, you’re allowed to contribute to a Roth IRA at any age. That means if you didn’t start saving for retirement until your 40s, you can still open a Roth IRA and make contributions.
A qualified distribution is made after the owner of the Roth IRA has reached 59.5 or becomes permanently disabled, or has passed away. These members have had their Roth IRA open for at least five years before being eligible for a qualified distribution. Additionally, they must have received no other distributions during the year of their qualified distribution. The distribution has to be made directly from the Roth IRA. You can take a qualified distribution from your Roth IRA without incurring any tax liability or a 10% penalty on the distributed amount. For example, if you’re over 59.5 and need $6,000 for a home down payment, you can withdraw it from your Roth IRA without penalty.
A non-qualified distribution is made at any other time than those detailed for qualified distributions. Additionally, to be a non-qualified distribution, the distribution must not meet the requirements of a qualified distribution. Non-qualified distributions are bound to income tax and, for Roth IRA owners under the age of 59.5 years old, may be subject to a 10% early withdrawal penalty. Non-qualified distributions from a Roth IRA are generally subject to ordinary income tax on earnings and the 10% early withdrawal penalty. Exceptions include:
- The distribution is for a first-time home purchase.
- The distribution is for medical expenses that exceed 7.5% of the taxpayer’s adjusted gross income.
- The distribution is used to pay health insurance premiums while the taxpayer is unemployed.
- The distribution is due to an IRS levy.
- The distribution is for a qualified reservist.
- The distribution is used to cover higher education expenses.
- The distribution is part of a series of substantially equal periodic payments.
Tax Implications of Qualified and Non-Qualified Distributions
As discussed above, qualified distributions are exempt from income tax and 10% penalty fees. Non-qualified distributions are bound to income tax and 10% penalty fees unless an exception applies. This is an important distinction that Roth IRA owners need to be aware of when planning retirement. Also, consider that distributions from a Roth IRA can satisfy the early withdrawal penalty exceptions for any qualified retirement account. This includes 401(k)s and traditional IRAs and pensions. However, only certain types of non-Roth accounts can be used to meet the early withdrawal exceptions for Roth IRAs.
When Can I Make a Qualified or Non-Qualified Roth IRA Distribution?
The earlier you begin a Roth IRA, the more time it has to grow and compound. This is why opening a Roth IRA in your teens or 20s will most likely give you a significant head start on retirement savings over starting one when you’re in your 30s or 40s. The rules for Roth IRA distributions are flexible, but they are not designed to provide retirement income before the owner of the account turns 59½. This is why taking qualified distributions in your 20s or 30s can be a smart move to get you started on saving for retirement. As always, it’s important to consult with a financial advisor to create a retirement plan that meets your specific needs.
A Roth IRA can be a significant part of your retirement savings plan. It offers tax-free growth and qualified distributions, which can help you avoid paying taxes on the money you withdraw during retirement. It’s 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. Also, be sure to consult with a financial advisor to create a retirement plan that meets your specific needs. Financial advisors are available to answer questions and provide guidance on the best ways to use your Roth IRA during retirement.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.