Early Distributions from IRAs & Retirement Plans: Penalties and Exceptions to Penalty

When someone withdraws money from a retirement plan or and individual retirement account (IRA) before retirement age, there may be federal penalties for premature withdrawals imposed by the IRS. Such penalties are in addition to the income taxes that are normally paid on retirement plan or IRA distributions.

Early Withdrawals

Here are six things from the IRS that you should know about early withdrawals from retirement plans:

1. An early withdrawal normally means taking money from your plan before you reach age 59½.

2. If you made a withdrawal from a plan last year, you must report the amount you withdrew to the IRS. You may have to pay income tax as well as an additional 10 percent tax on the amount you withdrew.

3. The additional 10 percent tax does not apply to nontaxable withdrawals. Nontaxable withdrawals include withdrawals of your cost to participate in the plan. Your cost includes contributions that you paid tax on before you put them into the plan.

4. A rollover is a type of nontaxable withdrawal. Generally, a rollover is a distribution to you of cash or other assets from one retirement plan that you contribute to another retirement plan. You usually have 60 days to complete a rollover to make it tax-free.

5. If you make an early withdrawal, you may need to file Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, with your federal tax return.

6. There are many exceptions to the additional 10 percent tax.

Tip: Some of the exceptions for retirement plans are different from the rules for IRAs, so be very careful here and check with tax counsel or your tax advisor.

Exceptions

Here some of the exceptions that can eliminate the penalty for a premature withdrawal of retirement monies:

Death or Disability of the Participant

Distributions on the death or disability of the participant.

Substantially Equal Periodic Payments

Distributions after separation from service in the case of a retirement plan or from an IRA that are part of a substantially equal periodic payments over the life of the participant or the joint lives of the participant and beneficiary.

Separation of Service Upon Reaching Age 55

Distributions after separation of service, provided the separation occurred during or after the calendar year in which the participant reached age 55.

Nonparticipant Distribution Pursuant to a QDRO

Distributions to a nonparticipant under a qualified domestic relations order (QDRO)

Amounts For Deductible Medical Expenses

Distributions not exceeding deductible medical expenses, determined without regard as to whether deductions are itemized.

Dividends From ESOPS

Certain distributions by Employer Stock Ownership Plans (ESOPs) of dividends on employer securities.

IRS Levy

Distributions made on account of an IRS levy against the participant’s account.

Qualified Hurricane or Recovery Assistance

Qualified hurricane or recovery assistance distributions.

Qualified Reservist Distributions

Qualified reservist distributions.

Conclusion:

Prudence dictates discussing contemplated premature distributions with your tax advisor before actually making such distributions.