how qualified distributions work
the government wants to encourage people to save for their later years it offers substantial tax benefits to those who save in qualified retirement accounts as a result many people pay into qualified plans in order to save for retirement these plans include iras 401 k s and 403 b s to make sure people don t abuse these accounts and use them for reasons other than retirement or to avoid paying taxes the irs imposes taxes and penalties on withdrawals that don t meet the qualified distribution criteria this means that if you withdraw money and the withdrawal does not meet the criteria for the account you will be taxed and could pay an additional tax penalty however if you meet the conditions you can make a qualified distribution for roth accounts you ll pay no taxes or penalties on qualified distributions for tax deferred accounts such as a traditional ira or a 401 k you ll pay no penalty but will owe taxes the rules for what constitutes a qualified distribution vary based on the type of account so it s important to know what they are before you consider making a withdrawal tax deferred retirement plans require that the account holder be at least 59 years of age to take a qualified distribution although the account owner will have to pay income tax on a tax deferred plan qualified distribution there will be no early withdrawal penalty tax deferred plans include traditional iras simplified employee pension iras savings incentive match plans for employees iras traditional 401 k s and traditional 403 b s 1unlike traditional iras roth iras do not provide a tax deduction for contributions in other words roths are funded with after tax dollars however roth iras do provide tax free withdrawals as long as certain criteria are satisfied 1 the criteria for a qualified withdrawal are if the distribution is qualified you ll pay no taxes on a roth ira withdrawal however if you fail to meet these requirements the withdrawal will not be considered a qualified distribution and you ll owe taxes and penalties on earnings 2designated roth accounts are employer sponsored plans such as a roth 401 k or roth 403 b with an after tax savings option these plans also have two requirements for qualified tax free distributions the first is the same as the roth ira the account must have been opened for at least five tax years the second requires the account holder to be at least 59 years of age permanently disabled or taking withdrawals from an inherited account whether or not you are buying a first home won t help you in this case 3special considerationsif you make an early withdrawal a 10 early withdrawal penalty will apply to the taxable portion of your non qualified distributions unless an exception applies for tax deferred accounts that means the entire distribution will be taxed unless you ve made nondeductible contributions 4for designated roth accounts early withdrawals are apportioned between your contributions which are tax free and therefore penalty free and your earnings which are taxed and penalized 5 for roth iras early withdrawals apply to all your after tax contributions before earnings are even considered those are tax and penalty free withdrawals subsequent early withdrawals are then taxed and penalized 2if you are taking an early taxable withdrawal you can avoid all or a portion of the penalty but not the income taxes if you qualify for an exception you can qualify if you if you re taking an early withdrawal from an employer plan you avoid the penalty if you re at least 55 years old when you leave your job penalty exceptions for ira account holders include first time homebuyer expenses up to 10 000 medical insurance premiums when unemployed and use of funds for qualified higher education expenses 4additional rules pertaining to certain qualified retirement accounts include required minimum distributions rmds after the account holder turns 73 as of 2023 for 401 k accounts there is an exception to this if you still work for the company that sponsors your 401 k when you turn 73 and you don t own more than 5 of the company it s possible to avoid rmds while you continue to be employed not all plans offer this so be sure to check with yours 67qualified distributions as direct and indirect rolloversdirect and indirect rollovers are key aspects of qualified distributions most rollovers whether direct or indirect occur when people change jobs but some occur when account holders want to switch to an ira with better benefits or investment choices in a direct rollover the retirement plan administrator transfers the plan s proceeds directly to another plan or an ira in an indirect rollover a plan administrator issues an employee a check that is to be deposited by the employee into another plan e g an ira with an indirect rollover it is up to the employee to redeposit the funds into the new ira within the allotted 60 day period to avoid penalty 8