What are early retirement distributions? If you take an early withdrawal from your retirement plan, then this will be subject to income tax and may be subject to an additional 10% tax penalty. This early withdrawal penalty is 10% of the taxable distribution you take from an IRA, a 401(k), a 403(b), or any other qualified retirement plan.
An early distribution is when you take a retirement distribution before reaching a certain age, usually age 59½ for most retirement plans.
However, there are some exceptions to avoid the additional 10% penalty.
IRA EXCEPTIONS
To avoid the 10% tax penalty when withdrawing from your IRA, one of the following cases must apply to you:
- You had a “direct rollover” to a new retirement account.
- You received the distribution, but within 60 days you rolled the money over into another qualified retirement account.
- You were permanently or totally disabled at the time of the withdrawal.
- You were unemployed and used the money to pay for health insurance premiums.
- You paid for medical expenses exceeding 7.5% of your adjusted gross income (AGI).
- You paid for college expenses for yourself, a spouse, a dependent, or a grandchild.
- You received the distribution as part of “substantially equal periodic payments” over your lifetime
- The IRS levied your retirement accounts to pay off tax debts.
- You’re a qualified first-time homebuyer, and you took distributions of up to $10,000. If you’re married and purchasing a first-time home together, this doubles to $20,000. You cannot have owned a home in the prior two years to qualify for the homebuying exclusion.
- The withdrawal is ordered as part of a divorce or martial separation under the terms of a Qualified Domestic Relations Order.
401(k) or 403(b) EXCEPTIONS
To avoid the 10% tax penalty when withdrawing from a 401(k) or 403(b), one of the following cases must apply to you:
- Distributions were made to your beneficiary or estate upon your death
- Distributions were made because you’re totally and permanently disabled.
- You were age 55 or older, and you retired or left your job. This age reduces to 50 for those that worked for public transportation for state or local governments.
- You received the distribution as part of “substantially equal periodic payments” over your lifetime. This only applies if you’ve stopped working for your employer.
- You paid for medical expenses exceeding 7.5% of your adjusted gross income (AGI).
- The withdrawal is ordered as part of a divorce or marital separation under the terms of a Qualified Domestic Relations Order.
- You are a qualified reservist. This applies to reservists who were called to active duty after the attacks on September 11, 2001, for at least 180 days.
- The distributions were from federal plans under a phased retirement program.
- The distributions were permissive withdrawals from a plan with automatic enrollment contributions
- You received distributions of dividends from an employee stock ownership plan.
REPORTING THE PENALTY
The additional tax penalty is figured using Form 5329 then directly transfers to your Form 1040. The additional tax penalty is reported on Schedule 2, and attached to your Form 1040.
It’s always beneficial to know what tax penalties you have coming your way, and if you have the option to avoid them! So, follow along to stay informed with tax tips this tax season!
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