Qualified vs. Nonqualified Roth IRA Distributions
By Mary Hopkins, CISP
When is a distribution considered a qualified Roth IRA distribution?
For earnings in a Roth IRA to be tax-free, a distribution must be “qualified.” A qualified Roth IRA distribution must meet two conditions. First, the Roth IRA owner must satisfy a five-year waiting period, which begins on the first day of the taxable year for which the Roth IRA owner made her first Roth IRA contribution, including any Roth IRA conversion. Second, the Roth IRA owner must meet one of the following qualified conditions: age 59½ or older, first-time homebuyer, disability, or death. Qualified Roth IRA distributions may be taken tax- and penalty-free.
What is a nonqualified Roth IRA distribution?
A nonqualified distribution occurs when an amount is taken before the five-year waiting period has been satisfied, or when an amount is taken after the five-year waiting period has been satisfied, but the Roth IRA owner has not met a qualified reason. Nonqualified distributions may be subject to tax and a penalty tax, as determined by the Roth IRA ordering rules.
What are the Roth IRA ordering rules?
The ordering rules address the order in which contributory assets and Roth IRA earnings are disbursed. Roth IRA owners are responsible for applying the ordering rules, and may refer to IRS Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs), and Form 8606, Nondeductible IRAs, for information. Individuals who have more than one Roth IRA must aggregate the assets in all of their Roth IRAs to determine the taxation of their distributions. Roth IRA assets generally are distributed in the following order.
Regular contributions
Conversions and retirement plan rollover assets (excluding rolled over designated Roth account assets), by year, with taxable assets distributed before nontaxable assets
Earnings on contributions and conversions, aggregated
Regular contributions are distributed first and are never subject to tax or a penalty tax. Once all regular contributions are depleted, conversions and retirement plan rollovers (excluding designated Roth account rollover assets) are distributed next. Each conversion and retirement plan rollover has a separate five-year waiting period that starts on the first day of the taxable year in which the transaction occurred. If the taxable conversion or retirement plan rollover amount is distributed within the five-year period, a 10 percent early distribution penalty tax applies unless the individual qualifies for a penalty tax exception. Earnings are the last assets to be distributed out of a Roth IRA. If an individual takes a nonqualified distribution, any earnings distributed are taxed as ordinary income and may be subject to penalty tax unless an exception applies.
