Life is complex, and if your circumstances require you to tap into your retirement savings account, know that you are not alone. According to a recent study, 51% of Americans have taken an early withdrawal.1
IRA and 401(k) accounts are essentially a deal with the government. In exchange for investing for retirement, the government allows preferential and/or deferred tax treatment. Most distributions from these types of accounts before the age of 59½ are considered “premature” and are subject to an extra 10% early withdrawal tax.
So, you may be asking: Is it possible to avoid the 10% early withdrawal tax? Knowing and navigating these rules may help you avoid substantial additional taxation.2
IRA and 401(k) Early Distribution Penalty Exemptions
The following are considered qualifying exemptions for the 10% early distribution penalty:
- Age. Withdrawals after the age of 59½.
- Death. It may be uncomfortable to think about, but it is worth knowing that any withdrawals after the death of the account holder are not subject to penalty.
- Disability. Total and permanent disability of the account owner.
- “Substantially equal periodic payments.” Under Rule 72(t), setting up substantially equal periodic payments for your life expectancy (or your designated beneficiary).3
- IRS levy. Do you owe the IRS money? You may be able to cover unpaid taxes using a penalty-free withdrawal.
- Medical. This includes unreimbursed medical expenses in excess of 10% of your adjusted gross income (AGI).
- Military. Qualifying distributions to military reservists during active duty.
- Rollovers. Must be properly executed within 60 days.
- Natural disaster. Some natural disasters are covered by temporary, event-specific legislation that allows penalty-free withdrawals on a case-by-case basis.4
IRA Early Distribution Penalty Exemptions
- Education. Including tuition, books, supplies, and other qualifying education expenses for you, your spouse, your children, and your grandchildren.
- First-time homebuyers. May withdraw up to $10,000 without penalty.
- Health insurance premiums. Premiums incurred during a period of unemployment.
401(k) Early Distribution Penalty Exemptions
- Separation from service. If separated from service after age 55 (age 50 for certain qualifying governmental public safety employees).
- Loans. If allowed by the plan, you may qualify for a 401(k) loan. It is not a withdrawal, but the account is treated as collateral.
Do It the Right Way!
Documentation is important. Make sure that you save all records and talk to the right people, such as your office human resources department and your financial professional. Hardship withdrawals may require proof at tax time. It’s important to also keep in mind that any dollar withdrawn is a dollar that won’t grow or be available during your retirement.
If you have to dip into your retirement account, don’t despair. You may have more time to recover than you initially think. Steady progress is important, starting with re-filling your emergency fund and paying off any high-interest debt. When you’re able, scale back your expenses and set up automatic deposits to ensure that money is going back into your investment account.
Are you still thinking about making an early withdrawal? Whether your withdrawal is exempt from penalty or not, a conversation with a financial professional might be the right place to start.
- https://www.bankrate.com/retirement/retirement-savings-survey-november-2021/
- https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions
- https://www.irs.gov/retirement-plans/substantially-equal-periodic-payments
- https://www.irs.gov/retirement-plans/disaster-relief-bill-includes-retirement-plan-distribution-and-loan-options
This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.
