If your distribution isn’t qualified per the IRS’ rules, withdrawing earnings from your Roth account may lead to implication of regular income taxes due on that portion and a 10% tax penalty if the withdrawal is made before you turn 59 ½ years of age. The basic IRS requirements for a qualified distribution is when a withdrawal is made:
From a Roth account open for at least five tax years, starting the year you first contributedAt age 59 ½ or olderDue to your disabilityDue to your death, by or for your beneficiaryUp to $10,000 to purchase, build, or renovate your first home
Let’s say you opened a Roth IRA with a brokerage a decade ago and contributed the maximum amount allowed. During that time, you gained significant earnings on your contributions. At age 59 ½, you decide to withdraw both your contributions and part of your earnings. Because you met the account and age requirements, your Roth IRA withdrawal is considered a qualified distribution. Therefore, you won’t face an early withdrawal penalty or any income taxes on the withdrawn earnings portion.
How a Qualified Distribution Works
Roth retirement account options from which you might take qualified distributions include the Roth IRA and designated Roth accounts such as a Roth 401(k), Roth 403(b), Roth Thrift Savings Plan (TSP), and Roth 457. You might get a Roth IRA on your own through a brokerage. On the other hand, a designated Roth account exists as an option for using post-tax dollars to contribute to an employer-provided plan. These options will differ based on how contributions occur and how you can qualify to make them. However, the benefit is you might end up better off if your post-retirement tax rate is higher than the year you made contributions. In addition, being able to access your Roth contributions tax-free offers some convenience and peace of mind. Qualified distribution rules come into play when you withdraw earnings from your Roth account. Unless you meet the IRS requirements for a qualified distribution, you’ll have to include the earnings—but not the original contribution—when you calculate your gross income on your tax return. Therefore, you’ll have to pay your current tax rate on the amount. This can particularly disadvantage you if you fall in a high tax bracket, since you have a lot of other income at the time. On top of paying taxes on your earnings, the IRS also requires you to pay another 10% tax for the early withdrawal. However, an exception may apply where you just need to pay the income taxes on earnings but not the additional penalty. For example, you can avoid the 10% penalty on Roth IRA earnings to pay for:
Qualified education costs, health insurance during unemployment Out-of-pocket medical costs that reach more than 7.5% of that year’s adjusted gross income Up to $10,000 for a first-time home purchase Up to $5,000 for a qualified adoption or birth
To see how a qualified distribution affects your taxes, let’s say you withdraw $5,000 from a Roth IRA. In this case, consider that your Roth account has $4,500 in contributions and $500 from earnings. As long as you meet the criteria for a qualified distribution, you don’t need to pay your current tax rate on the $500 in earnings. You may or may not be subject to a 10% early withdrawal penalty depending on your age.
Qualified Roth Distribution vs. Eligible Roth Rollover
You can do this through a direct rollover, where you withdraw the funds and deposit the money yourself in the new Roth account. Alternatively, you can select an indirect rollover, where the plan holder transfers the funds to the new Roth account. As long as you follow the IRS directions for the rollover, you can avoid the 10% penalty and income taxes on earnings. Specifically, you’ll have 60 days for the removed funds to be put in the new Roth account. In addition, if you’re rolling over from one Roth IRA to another, you can only do so once per year. If you don’t meet these requirements, the IRS will reclassify the attempted rollover as a Roth account distribution, with your earnings subject to the usual tax treatment. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning!
