What is 'Non-Qualified Distribution'

Non-qualified distribution can refer to two scenarios: either a distribution from a Roth IRA that occurs before the IRA owner meets certain requirements, or a distribution from an education savings account that exceeds the amount used for qualified education expenses.

BREAKING DOWN 'Non-Qualified Distribution'

The distinction between qualified and non-qualified retirement plans is worth noting. Qualified give members tax benefits, with employers deducting certain pretax wages from employees, that can increase, tax-deferred until they are withdrawn. Non-qualified plans aren't eligible for tax deferral, so contributions to non-qualified plans can be taxed.

Non-qualified distribution in education savings vs. Roth IRAs

The two main types of non-qualified distribution are with education savings accounts and Roth IRAs. For education savings, "non-Qualified Distribution may be subject to a 10 percent federal income tax penalty in addition to any income taxes that may be due," as one state agency explains.

"There may also be state tax consequences. The earnings portion of a non-qualified distribution is taxable to the individual who receives the payment, either the account owner or the designated beneficiary. If the payment is not made to the designated beneficiary or to an eligible educational institution for the benefit of the designated beneficiary, it will be deemed to have been made to the account owner."

As for Roth IRAs, qualified distributions usually require that the account is at least five years old with the account holder more than 59-and-half years in age and making a withdrawal due to a first-time home purchase or disability or death. Withdrawals that don’t fit the criteria above are generally classified as non-qualified Roth IRA distributions. 

However, you are allowed to withdraw any contributions that you made to a Roth IRA tax free and penalty free, at any age  without the account needing to be five years old. Though this  rule applies only to  contributions. The earnings that your account generates on those contributions are not included.

Additionally, it's worth noting that non-qualified Roth distributions are taxed as income. You will also be subject to a 10 percent early withdrawal penalty if you are younger than 59½. Depending on your tax bracket, this can add up to a considerable sum. If you  have to take an early distribution for any reason, understanding the rules that determine whether it is a qualified or non-qualified Roth IRA distribution can help you minimize the amount of taxes and penalties to which you may be subject.

RELATED TERMS
  1. Non-Qualifying Investment

    A non-qualifying investment is an investment that does not qualify ...
  2. Ordering Rules

    Ordering rules describe the order in which Roth IRA assets are ...
  3. Deferred Account

    A deferred account postpones tax liabilities until a future date.
  4. Roth 401(k)

    A Roth 401(k) is an employer-sponsored investment savings account ...
  5. IRA Plan

    An IRA plan is an investment account individuals may establish ...
  6. Education IRA

    An education IRA is a tax-advantaged investment account for higher ...
Related Articles
  1. Financial Advisor

    How to Help Clients Manage Roth IRA Distributions

    Here's how the five-year rule works with Roth IRAs and what to consider for clients.
  2. Retirement

    The Potential Benefits of a Roth IRA

    No one knows when taxes will increase. With a Roth IRA, future distributions are tax-free.
  3. Retirement

    Are You Too Old to Benefit from Opening a Roth IRA?

    You may not be too old to open a Roth IRA. Roth IRAs can offer significant retirement income security and tax advantages, even for older workers.
  4. Financial Advisor

    Why You Should Have a Roth IRA

    The world of retirement savings plans is filled with options. Here are the reasons why you should consider a Roth IRA when saving for retirement.
  5. Financial Advisor

    Roth IRAs Tutorial

    This comprehensive guide goes through what a Roth IRA is and how to set one up, contribute to it and withdraw from it.
  6. Retirement

    Roth vs. Traditional IRA: Which Is Right For You?

    To answer this question, you need to consider several of the factors we outline here.
  7. Retirement

    5 Secrets You Didn't Know About Roth IRAs

    Between its generous tax benefits at retirement and no required minimum distributions, a Roth IRA is well worth considering if you're eligible to have one.
  8. Retirement

    Why a Roth IRA May Be the Better Choice

    Both traditional and Roth IRAs are good for funding retirement, but here's why the Roth is better.
Hot Definitions
  1. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  2. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  3. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
  4. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  5. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  6. Cost of Debt

    Cost of debt is the effective rate that a company pays on its current debt as part of its capital structure.
Trading Center