Investor Facts: What Is A Qualified Distribution?

A qualified distribution is money taken from a tax-advantaged account, such as an individual retirement account (IRA), workplace 401(k) or a college savings plan.

People save money in tax-qualified accounts because they expect to take a distribution later, typically in retirement for living expenses. If the account is tax-qualified the removal of money is considered a qualified distribution.

A qualified distribution generally refers to distributions coming from a tax-qualified account, such as an IRA or 401(k).

Qualified distributions may or may not be taxable. As the term is commonly applied to retirement accounts, it is important to note the differences between pre-tax and post-tax contributions and how they are treated at distribution, when money is paid out to the owner of the account.

Pre-tax accounts: Let’s explore the standard taxation angle first. Distributions are held to be qualified typically when they come from an account where a tax break is applied to contributions and taxes on the growth of those contributions is deferred. An example is a 401(k) plan at work.

At the time of a qualified distribution of funds back into the investor’s pocket, the amount paid out is subject to federal and state income taxes. Penalty taxes can be applied if the investor is under the minimum retirement age, although there are exceptions.

Post-tax accounts: Money removed from a Roth account, whether in a 401(k) or IRA, also is considered a qualified distribution, though it is generally not taxable since the investor already paid income taxes on those contributions.

There are specific requirements to ensure that a Roth withdrawal is a qualified distribution, some age-related and some related to the age of the Roth account itself.

College 529 plans: Other accounts unrelated to retirement can generate qualified distributions. Here, however, taxation is not as much a concern if the distribution meets certain requirements. A 529 college savings plan is a good example.

In order for a 529 plan distribution to be qualified, the funds must be used toward higher education expenses of the beneficiary. If the expenses meet this test, they are considered to be qualified distributions and escape taxation. If they do not meet the requirement, appropriate taxes on the distribution are applied.

Bottom line, an investor who sees the term qualified distribution should recognize that there are going to be specific rules for taking a withdrawal from that investment account and be ready to dig further into the details.

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