If you take a distribution from your designated Roth account before the end of the 5-taxable-year period, it is a nonqualified distribution. You must include the earnings portion of the nonqualified distribution in gross income. However, the basis (or contributions) portion of the nonqualified distribution is not included in gross income. The basis portion of the distribution is determined by multiplying the amount of the nonqualified distribution by the ratio of designated Roth contributions to the total designated Roth account balance. For example, if a nonqualified distribution of $5,000 is made from your 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 your gross income) and $300 of earnings (that are includible in your gross income).
How Are Nonqualified Distributions Treated?
If your distribution is a nonqualified distribution:
The portion of the distribution that represents your contributions to the account will be nontaxable (and not subject to the 10% penalty), and
The portion of the distribution that represents earnings (i.e., growth) will be taxable and potentially subject to the 10% penalty.
In determining what portion of the distribution is considered to come from contributions as opposed to earnings, each distribution is simply treated on a pro-rata basis. For example, if you currently have $10,000 in your Roth 401(k), of which $8,000 is from contributions and $2,000 is from earnings, any distribution will be considered to come 80% from contributions and 20% from earnings — meaning that 80% of the distribution will be nontaxable, and 20% will be taxable and possibly subject to a 10% penalty.
Any portion of a nonqualified distribution that comes from earnings will be subject to the 10% penalty unless one of the following requirements is met. (Note that these are the same requirements as for regular 401(k) distributions.)