Early Distributions of Retirement Funds

Early withdrawals from retirement plans may be taxed twice

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Whenever you take a distribution from your IRA, 401(k), or other retirement savings plan, Uncle Sam is waiting. You must generally include that money as taxable income on your tax return. The withdrawal might also be subject to an additional penalty tax—as much as 25% under some circumstances.

The Penalty Tax

The penalty tax kicks in when you take a distribution before reaching a certain age, usually 59½, although there are some exceptions to this rule. The penalty is normally 10% of the taxable amount when you take an early distribution from an individual retirement account (IRA), a 401(k), a 403(b), or another qualified retirement plan before reaching age 59½. The taxable amount must also be included in your taxable income, so you'll pay ordinary income tax on the distribution amount as well.

The additional tax increases to 25% if you take the distribution from a traditional IRA within two years of the date you first began participating in the plan.

Exceptions to the Usual Rules: IRAs

There are to these rules. Exceptions for early distributions from IRAs include the following circumstances: 

  • You had a "direct rollover" to your new retirement account using a trustee-to-trustee transfer.
  • You received a payment but rolled the money over into another qualified retirement account within 60 days.
  • You were permanently or totally disabled.
  • You were unemployed and used the money to pay for health insurance premiums.
  • You paid for college expenses for yourself or a dependent or a grandchild.
  • You received the distribution as part of "" over your lifetime.
  • You're a qualified first-time homebuyers and you took distributions of up to $10,000.
  • You paid for medical expenses exceeding 10% of your adjusted gross income.
  • The IRS levied your retirement account to pay off tax debts.
  • The distribution represents a return of nondeductible contributions.
  • It was a non-qualified distribution from a Roth IRA.

You cannot have owned a home in the previous two years to qualify for the homebuying exclusion, and only $10,000 of the retirement distribution will avoid the tax penalty. If you take $15,000, you'll be hit with the penalty on the $5,000 balance.

You don't have to itemize on your tax return to claim the medical expense exception.

Qualified Retirement Plans: 401(k)s or 403(b)s 

Exceptions for early distributions from qualified retirement plans include the following circumstances: 

  • Distributions were made upon the death or disability of the plan participant.
  • You were age 55 or over and you retired or left your job.
  • You were age 50 or over and you retired or left your job as a public safety employee of a state government.
  • You received the distribution as part of "substantially equal periodic payments" over your lifetime.
  • You paid for medical expenses exceeding 10% of your adjusted gross income.
  • The distributions were required by a divorce decree or separation agreement under the terms of a "." 
  • You received distributions of dividends from an .
  • They were recovery assistance distributions.
  • They were qualified reservist distributions.
  • They were distributions from federal plans under a phased retirement program.
  • They were permissive withdrawals from a plan with automatic enrollment features.
  • They were corrective distributions and/or earnings associated with excess contributions.

Nontaxable Withdrawals

You generally if you take a distribution on which no tax is due. In other words, your contribution represents principal only and you paid tax on those dollars before you invested them. The bottom line is that you did not take a tax deduction for your contributions, nor did your employer divert funds to your plan before calculating taxes on your pay.

Rollovers are also nontaxable, which is why they don't incur a penalty.

The Age 50 Rule

Certain government employees can access their retirement savings starting at age 50 rather than waiting until age 55 if they retire or leave their jobs early. These employees include nuclear materials couriers, United States Capitol Police, Supreme Court Police, and diplomatic security special agents. This rule applies to distributions from governmental defined benefit and defined contribution plans for employees who separate from service after reaching 50 years of age.

This change was made effective in 2016 as part of the Protecting Americans from Tax Hikes Act of 2015.

Reporting the Early Distribution Penalty

You can figure the additional tax directly on your Form 1040, or you can use . Your best option depends on your particular tax situation. Generally, you would calculate the additional tax penalty on Form 5329 if you qualify for one of the exceptions and your retirement plan did not report the exception on Form 1099-R in box 7. If the exception is properly coded in box 7 of your 1099-R form, you don't have to fill out Form 5329.