What’s A Roth Qualified Distribution?

Investors are often confused about what they can and can’t do with their Roth IRA.  The Roth is so flexible compared to other retirement vehicles that much is written – sometimes incorrectly – about how the IRA funds can be withdrawn.  Here’s a quick look at which distributions are qualified, and which are not.  For further clarification, see you Roth IRA professional.

Definition of “Qualified Distribution”

A qualified distribution is when you withdraw funds from your Roth IRA in a manner that is both tax and penalty free.  The main two requirements are:

1. It must occur at least five years after the Roth IRA was established and funded
   1. At least one of the following requirements must be met:
      1. The Roth IRA holder must be at least age 59 1/2 when the distribution is made
      2. No more than $10,000 is used towards the purchase of a first home for a qualified family member.  Qualified family members include:

i.    The Roth IRA owner

ii.    The owner’s child

iii.    The owner’s grandchild

iv.    A parent of the owner

1. The Roth IRA owner becomes disabled.
2. The funds are distributed to a beneficiary of the Roth IRA owner after death.

So, there are two requirements that must be met in order for a Roth IRA distribution to be qualified: The distribution rules and the five-year rules. Unless both sets of rules are met, the distribution is not qualified, and the earnings will be subject to tax, and possibly penalties.

Taxes on an Unqualified Distribution

Let’s first discuss taxes.  When you put money into your Roth, you had already paid the taxes on the invested money.  You won’t have to pay taxes on your invested money again, no matter when you withdraw it.  What you will have to pay taxes on is the money your IRA earned.  If you deposited $5,000, earned $1000 in two years (a pretty good rate of return) and then withdrew $6,000, you’d owe taxes on the $1,000, at whatever your marginal tax rate is.

Penalty on an Unqualified Distribution

With few exceptions, a distribution before the owner turns 50 ½ will be subject to a 10% penalty of the amount of the distribution.  This penalty is levied in addition to the taxes owed.  In addition to the qualified distributions listed above, the early withdrawal penalty does not apply to distributions that:

• Are a series of “substantially equal periodic payments” made over the life expectancy of the IRA owner.
• Are used to pay for unreimbursed medical expenses that exceed 7 1/2% of adjusted gross income (AGI).
• Are used to pay medical insurance premiums after the IRA owner has received unemployment compensation for more than 12 weeks.
• Are used to pay for the qualified expenses of higher education for the IRA owner and/or eligible family members.
• Are used to pay back taxes because of an Internal Revenue Service levy placed against the IRA.

Investors should now have a pretty good idea about what is and isn’t a qualified Roth IRA distribution, and what the penalties are for “breaking the rules”.  A good understanding of the above should help an investor plan not only for retirement, but for unexpected events as well.

Share This!