It’s not unusual these days for people to take an “early distribution” from their retirement plan (early meaning before they reach the age of 59 1/2).

If any taxpayer takes an early withdrawal from a “qualified retirement plan”, the taxpayer will pay income tax on the amount taken AND a 10% penalty.

A “qualified retirement plan” is:

1. Any typical employer pension or profit sharing plan
2. Any tradiional IRA account (ROTH IRAs have penalty provisions for “early” withdrawals too, but I’m not talking about ROTH IRAs here)
3. Any tax‐sheltered or retirement annuity
4. Any plan that ever was treated as one of the prior three plans, even if it isn’t now.

Most people understand that they’ll pay income tax on the money they withdraw, but what’s up with this 10% penalty?

Congress created these “plans” for retirement savings and so they want to encourage taxpayers to keep that money for retirement. One part of the encouragement is penalize you if you take it early.

However, there are exceptions to those penalties. They are:

1. Distributions made to a beneficiary (or to the estate of the employee) on or after the death of the employee.
2. Distributions attributable to the employee being disabled.
3. Distributions which are part of a series of substantially equal periodic payments. Basically means the payments you get are spread out over your lifetime.
4. Distributions made to an employee after separation from service after attainment of age 55. This rule doesn’t apply to distributions from IRAs.
5. Distributions which are dividends paid with respect to stock of a corporation which is in an ESOP.
6. Distributions on account of an IRS levy (the IRS took the money; not that you took a distribution to pay a levy).
7. Distributions made to the employee to the extent they don’t exceed the amount allowable as a medical expense on their tax return. So, suppose a taxpayer can deduct $5,000 of medical costs on their personal tax return in a tax year. They can avoid the 10% penalty on $5,000 of whatever the amount is they distribute.
8. Any distribution made to an alternate payee under a qualified domestic relations order that relates to child support, alimony or marital property rights.
9. IRA distributions to certain unemployed individuals for health insurance premiums.
10. A distribution of a “first-time” homebuyer (someone who did NOT have an ownership interest during the two-year period ending on the “date of aquisition”); maximum amount to avoid penalty on = $10,000.
11. A distribution to pay higher education costs that were incurred in that same calendar year.

Of course, all of these have specific rules and qualifications that I have not mentioned here.

If you have a question regarding your situation, please contact me.

jeff@vmde.com

(616) 949-9030 ext 14