Many people have been dipping in to their retirement savings in order to make ends meet. What many people don’t realize is that there is a 10% penalty on most early withdrawals from IRA’s and qualified accounts such as 401(k)’s if they are made before the age of 59 1/2. This 10% penalty is in addition to the income tax that must be paid on the withdrawal amount at the taxpayer’s individual tax rate.
There are some exceptions to this 10% penalty that many people may not be aware of. If the money is used for any of the reasons below you could avoid the 10% penalty. Some of these exceptions only apply to IRA’s and some only apply to qualified accounts, so be sure to consult with your tax advisor regarding your specific situation. You will also need to notify your tax preparer that you used the money for one of the reasons listed below as that information will not be reported on the 1099-R tax form you will receive in the year of distribution.
Exceptions:
•Distribution made to an employee who has attained age 55 and separated from service
•Distribution is part of a scheduled series of substantially equal periodic payments made over the life expectancy of the participant or joint lives of participant and his beneficiary
•Distribution made due to total and permanent disability
•Distribution made due to death of the employee or account owner
•Distribution to the extent the individual’s unreimbursed medical expenses exceed 7.5% of his AGI
•Distribution made to an alternate payee pursuant to a qualified domestic relations order (QDRO)
•Distribution to pay for health insurance premiums for certain unemployed individuals
•Distribution to the extent of the qualified higher education expenses for the year of the taxpayer, spouse, child or grandchild
•Distribution for first-time home purchases (no home ownership in prior two years). This distribution is limited to $10,000 (lifetime)
•Distribution due to an IRS levy on the qualified plan or IRA. This exception will not apply if funds are withdrawn to avoid a levy or to satisfy a levy on other property
•Distribution to reservists while serving on active duty for at least 180 days
Got to watch out for that 10% That's a lot.
ReplyDeleteYes you do. It is surprising how many people get caught paying this penalty. Mistakenly they think that the tax and penalty is withheld when they take a distribution. Administrators of 401(k) plans are required to withhold 20% for federal income taxes. Those taxpayers taking early distribution from 401(k) accounts believe that this 20% is all the tax and penalty they will have to pay but the penalty is in addition to federal and state income tax if applicable. I've seen taxpayers pay 25% fed 5% state plus the penalty of 10% for a grand total of 40%.
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