Terry Herr, CFP®, CLU
Life is complex, and if you find the need to tap into your retirement savings account, you are not alone. In some cases, it may be the right move, or you might not have a choice. According to a recent study, more than half of investors aged 18–34 years have already tapped into their tax-advantaged retirement account.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. If you have not reached the age of 59 ½ yet, most retirement plan distributions from these accounts are considered “premature” and are subject to an extra 10% early withdrawal tax.
So what are the exceptions to the 10% early distribution tax? 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 to the 10% early distribution penalty:
- Age. Withdrawals after the age of 59 ½.
- Death. It may be unfortunate to think about, but 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 receive temporary, event-specific legislation allowing penalty-free withdrawals on a case-by-case basis.4
IRA Early Distribution Penalty Exemptions
- Education. These include tuition, books, supplies and other qualified education expenses for you, your spouse, children and even grandchildren.
- First-time homebuyers may withdraw up to $10,000 without penalty.
- Health insurance 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 you’re saving records and talking to the right people, such as your office human resources department and your financial professional. Hardship withdrawals may require proof once it’s time to pay taxes. It’s important to also keep in mind that any dollar taken out is a dollar that won’t grow or be available for your future 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. Once you’re able, you may want to scale back expenses and set up automatic deposits to ensure that the money is going back into your investment account.
Are you still thinking about making an early withdrawal? Whether your withdrawal falls under the exemption or not, contact us and we can walk you through your decision. Contacting us might be the right place to start.
This content is developed from sources believed to be providing accurate information. 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.