401K and IRA Early Withdrawal

Distributions from an IRA, 401(k) or other retirement plan generally must be included as part of your taxable income.   Withdrawals from a retirement account may also be subject to an additional tax of 10% if the distribution is made before the investor reaches the age 59.5 years old.  If money is withdrawn from a SIMPLE IRA and the investor first began participating in a SIMPLE IRA plan within the past two years the distribution penalty is 25% instead of 10%.

Penalty for Early Fund Withdrawal

A withdrawal of money from a qualified retirement plan may subject the recipient of the funds to an additional tax of 10%. This is the penalty for taking an early distribution of funds out of an individual retirement account (IRA), 401(k), 403(b), or other qualified retirement plan before reaching age fifty nine and one half.  

There are some exceptions to the 10% penalty.   A little known fact is that the penalty may apply to Roth IRAs, even if it has been at least five years since you first opened up your Roth account.   For Roth IRA account holders, it will be crucially important to review the exceptions to the 10% penalty or otherwise the early distribution of Roth funds could become subject to both tax and the 10% penalty. See more on Early Withdrawal Rules for IRAs

Exceptions to the Early Withdrawal Penalties

A taxpayer will not have to pay the additional 10% tax penalty on an early retirement distribution if he can qualify for certain exceptions. There are two sets of exceptions. The first set below applies to individual retirement accounts (both traditional and Roth IRAs). The second set of exceptions applies to 401(k) and 403(b) retirement plans.

Exceptions for Early Withdrawal from an IRA:

• You had a "direct rollover" to your new retirement account,
• You received a lump-sum payment but rolled over the money to a qualified retirement account within 60 days,
• You were permanently or totally disabled,
• You were unemployed and paid for health insurance premiums,
• You paid for college expenses for yourself or a dependent,
• You bought a house,
• You paid for medical expenses exceeding 7.5% of your adjusted gross income, or
• The IRS levied your retirement account to pay off tax debts.

Exceptions for Early Distributions from a Qualified Retirement Plan such as a 401(k) or 403(b) plan:

• Distributions upon the death or disability of the plan participant.
• You were age 55 or over and you retired or left your job.
• You received the distribution as part of "substantially equal payments" over your lifetime.
• You paid for medical expenses exceeding 7.5% of your adjusted gross income.
• The distributions were required by a divorce decree or separation agreement ("qualified domestic relations court order").

Legal Help for 401K Tax Penalties

It is important to have the assistance of a tax attorney to help you sort out what you might owe in penalties and taxes due to an early withdrawal of retirement funds.  An attorney can aid you in determining the additional taxable income and helping you find the correct way to report the income.   Some exception may be reported on a 1099-R form box 7 and others are reported on the usual 1040 form.  An attorney may be of valuable assistance in properly reporting the early withdrawal as income to IRS and successfully claiming an exception to the tax penalty.