What are Qualified Distributions?

A qualified distribution is a withdrawal from a retirement account that does not result in an early withdrawal penalty. For retirement accounts that are generally withdrawn on a tax-free basis if the withdrawals are made when the account owner is the appropriate age or for certain exceptions, than a qualified distribution from that retirement account is also one that is not subject to income taxes.

Roth and Traditional IRA Distributions

Normal qualified distributions from a Roth or Traditional IRA account occur when the account owner takes withdrawals from the account after the age of 59.5 years old, and at least five years after the account was opened.

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In certain situations, a withdrawal may be made without penalty from a retirement account before the account owner is the age of 59.5 years: if the account owner becomes disabled; if the account owner dies and the funds are distributed to the account beneficiary; or up to $10,000 may be withdrawn for purchasing or rebuilding a first home for either the Roth or Traditional IRA account holder or a qualified family member.

Qualified distributions from a Roth or Traditional IRA are made without early distribution penalties. If money is withdrawn from an IRA on a non-qualified basis, income taxes and a 10% early withdrawal penalty will be applied. You cannot avoid paying regular income taxes on the money withdrawn, so even if your situation allows you to avoid the additional 10% early withdrawal penalty, you need to consider the impact on your taxes if you tap into your retirement money.

However, one of the perks of using a Roth IRA is you only pay the 10% early withdrawal penalty if you withdraw from the earnings of your investments. You are free to withdraw your initial contributions at any time regardless of your age.

SIMPLE IRA Distributions

The SIMPLE IRA distributions follow the same rules as the Roth IRA, with the exception of a higher penalty if you withdraw money within two years of opening the SIMPLE IRA. An early distribution penalty for SIMPLE IRA accounts withdrawn within two years of opening is 25% rather than 10%.

401k and 403b Distributions

Qualified distributions from 401k or 403b retirement plans are generally made when the account owner reaches the age of 59 and a half years old, dies, becomes disabled, or the plan itself terminates by the employer. Qualified distributions can be taken in a lump-sum distribution or through regular installment payments. You must begin taking distributions by April 1st during the year you reach the age of 70 and a half if you haven’t already and even if you are still working; or by April 1st of the year you retire.

Under a 401k plan, some employers may allow employees to receive money as a hardship distribution due to a financial need. Funds withdrawn under a hardship may pay for medical care of the employee, the spouse, or dependents; costs for mortgage payments or housing purchase; educational fees; or funeral expenses. An alternative to a hardship distribution is simply borrowing the money from your 401k.

If you take an early distribution from a 401k or 403b plan, before the age of 59 and a half, you will have to include the amount withdrawn in your taxable income, and pay an additional 10% tax on the distribution. The only exceptions for avoiding the 10% early withdrawal penalty is if the payment is being made to a beneficiary as a result of the account owner’s death; if the account owner has a qualifying disability; is required as part of a divorce decree; used for medical care; made because the IRS levied the plan; or used to pay for natural disasters as claimed by the IRS.

How to Report an Early Distribution Penalty on Your Income Taxes

If you must make an early distribution from a retirement plan, you will need to report the withdrawal and penalty on your income taxes. You can determine the additional tax owed on Form 1040 or Form 5329.

About the Author

By , on Jul 27, 2011
Tisha Tolar
Tisha Tolar is a co-owner of Trifecta Strategies, LLC and the author of Gen X. When she is not busy being a fiction writer, she writes personal finance articles for several web sites, including Moolanomy.com.

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Leave Your Comment (One Comment)

  1. krantcents says:

    Since I am already over 591/2, I am less concerned about early withdrawal. Since I plan on living 25-30 years in retirement (again) beginning when I will be 701/2, I plan to withdraw 3% each year.

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