3781 / How are nonqualified distributions from a designated Roth 401(k) or 403(b) account taxed?

A nonqualified distribution from a designated Roth account generally is partially nontaxable. The portion of the distribution that constitutes the employee contribution is not taxable, and the portion that relates to earnings on those contributions is taxable.¹ A nonqualified distribution may be rolled over to a Roth IRA. The funds in a designated Roth account are not subject to the ordering rules that determine the tax treatment of Roth IRA distributions ( Q 3673) unless they are rolled over to a Roth IRA.²

The preamble to the proposed regulations illustrated the pro rata treatment of nonqualified distributions as follows: If a nonqualified distribution of $5,000 is made from an employee’s designated Roth account when the account consists of $9,400 of designated Roth contributions and $600 of earnings, the distribution consists of $4,700 of designated Roth contributions (that are not includible in the employee’s gross income) and $300 of earnings (that are includible in the employee’s gross income).

Amounts not treated as qualified. Certain amounts that are not eligible rollover distributions never can be treated as qualified distributions, and always will be currently includible in income. These include corrective distributions of excess deferrals, excess contributions and attributable income ( Q 3808), deemed distributions resulting from violations of the plan loan requirements ( Q 3954), and the cost of current life insurance protection ( Q 3948).³