Penalties on Early Retirement Plan Distributions Explained

    When money gets tight, it can be tempting to tap into a retirement account. While it can seem like an easy, painless way to pay off some bills, it can be very expensive come tax time. A quick fix can become a painful burden.

    If you take any money from a “qualified retirement plan” (an IRS-approved plan set up by an employer) before you turn 59 1/2, it is an early distribution. Early distributions are generally taxable AND subject to an additional 10% penalty. For example, a person in the 25% tax bracket who takes a $5,000 early distribution from his 401(k) plan could have to pay $1,250 in federal income tax plus $500 for the penalty, as well as perhaps $340 in New York state income tax.

    There are some specific exceptions to the penalty (but not the tax).  You may be able to avoid the additional 10% for some or all of any distributions that are:

    • Due to death
    • Due to the account owner’s disability
    • Withdrawn in substantially equal periodic payments
    • Due to separation from service after age 55 (employer-provided plans only)
    • Equal to medical expenses exceeding 10% of adjusted gross income
    • On account of an IRS levy
    • Under a qualified domestic relations order (employer-provided plans only)

    Note that "hardship" is not one of the exceptions. Although some employer plans allow "hardship withdrawals" to allow you access to the money, any such withdrawals are still subject to both income tax and the 10% penalty (unless one of the exceptions above applies).

    You can also take early distributions from a Traditonal IRA at any time, and there are some additional exceptions that only apply in this case, including:

    • Health insurance related distributions for when you are unemployed
    • A portion of distributions taken for qualified higher education expenses
    • A portion of distributions taken for first-time home purchases

    It is important to know which exceptions apply to which types of plans. If you take an early distribution from an IRA to pay qualified higher education expenses, the 10% penalty does not apply. However, if you take an early distribution from a 401(k) for the same purpose, the penalty does apply.

    It’s always best to seek the advice of a tax professional before taking ANY distribution from ANY retirement plan. If you have questions, please feel free to contact our tax professionals.