Withdrawals made from your retirement account (e.g., 401(k), 403(b), 457(b) IRA, SIMPLE IRA, etc.) before you have turned
59 ½ years old will generally incur a penalty of 10% in addition
to regular income tax on the withdrawn amount. For example, a withdrawal
of $5,000 by someone in the 25 percent tax bracket would incur $1,250
of federal tax and a $500 penalty for a total of $1750. Generally, a mandatory
20% withholding tax applies for all withdrawals. Nevertheless, it may
be possible to avoid the 10% early withdrawal penalty if you qualify for
one of the following exceptions:
- After turning age 59 ½ you are allowed to withdraw any amount you
want without the 10% penalty.
- If you use the withdrawal to pay the costs of higher education for yourself,
your spouse, your children, or grandchildren, you can avoid the early
withdrawal penalty. Expenses such as tuition, fees, books, and room and
board for at least half-time students will get you this exemption.
- If you purchase your first home or merely make capital improvements to
your first home, you can take a penalty-free IRA distribution of up to
$10,000 or $20,000 for couples.
- Distributions can be used to pay unreimbursed medical costs in excess of
10% of your adjusted gross income without incurring the early withdrawal
fee, but only if the distribution is used the same year as the medical
expense. You are not required to itemize your deductions to substantiate
the medical expenses.
- Distributions can be taken without a penalty to pay health insurance for
you, your spouse, and your dependents after a period of unemployment.
You need to receive unemployment compensation for 12 straight weeks due
to job loss in order to qualify.
- If you become disabled such that you cannot find work, you can qualify
for an exemption so long as a medical professional can corroborate your
- If you die before reaching 59 ½ your IRA can be distributed to a
beneficiary without the 10% penalty.
- Setting up a series of annuity payments from your IRA will not incur the
early withdrawal penalty. You will need to use an IRS-approved distribution
method and take at least one withdrawal annually to avoid the penalty.
- No penalty is incurred for withdrawals taken by members of the military
reserves who were called to active duty after September 11 2001 for at
least 179 days or an indefinite period. You must take this distribution
during active duty.
- Withdrawals from a Roth IRA if it is at least five years old are without
penalties if the withdrawal is made from your contributions.
- Employees who leave their jobs at or after the age of 55 can make 401(k)
withdrawals without the 10% penalty. If, however, you roll the funds into
an IRA, you will need to wait until you are 59 ½ to avoid the penalty.
- Distributions of dividends from an ESOP if the dividends are attributable
to the employer’s stock.
Distributions to a former spouse pursuant to a divorce property settlement
or separation agreement, and distribution to an alternate payee pursuant
to a qualified domestic relations order (e.g., child support or alimony). This has given rise to “paper divorces”
whereby couples utilize divorce as a tax planning tool.
- Distributions to non- citizens (e.g., lawful permanent resident “green
card holders,” U.S. visa holders, and nonresidents) have the potential
for avoiding by the 10% early withdrawal penalty, the 20% withholding
tax, and even regular federal income tax altogether. This is a highly
technical exception that requires a client engagement for international
treaty-based tax planning.