The information in this article is up to date through tax year 2019 (taxes filed in 2020).
Withdrawing money from a qualified retirement plan or IRA is tempting when you’re in need of money for medical bills, home improvement projects, major purchases or any costly life situation. But, when you cash out funds from one of these accounts, you may get hit with a penalty if an exception is not available.
What is an early retirement withdrawal?
An early retirement withdrawal – also known as early retirement distribution – means taking money out of an IRA, Roth IRA, 401(k), or any other qualified retirement plan before the age of 59½. As a result, you must pay an additional 10% tax penalty along with your regular income tax. The penalty increases to 25% if you withdraw money from a traditional IRA plan within two years of the account’s start.
The 10% tax penalty doesn’t apply to nontaxable withdrawals. The most common type of nontaxable withdrawal is a rollover, which is when you take money out of one plan and transfer it to another plan.
Exceptions to the tax penalty
The IRS offers expectations to the 10% tax penalty for certain situations. You still have to report your withdrawal as income, but you don’t have to pay the penalty. Here are some of the common exceptions the IRS allows:
- Medical Expenses: This exception only applies if your expenses exceed 10% of your adjusted gross income and weren’t reimbursed by your health insurance.
- Separation from Service: If you left or retired from your job during or after the year you turned 55, you won’t be penalized. You also won’t be penalized if you left off retired from a qualified public safety position during or after the year you reach age 50. However, these exceptions are applicable only for a qualified retirement plan such as a 401(k) or 403(k).
- Higher Education Expenses: You can be exempt from paying the 10% tax penalty if you take money out of a traditional IRA to pay for qualified college expenses including tuition, fees, books, equipment, etc. Room and board are also covered if you’re at least a half-time student.
- First Home Purchase: Qualified first-time homebuyers are able to withdraw up to $10,000 from an IRA without incurring the 10% tax penalty. Couples can withdraw up to $20,000.
- Disability: If you have a severe physical or mental disability and are unable to work, you can withdraw money from an IRA or qualified plan without the 10% tax penalty, as long as your doctor signs off on your condition.
- Military Service: Military reservists who withdraw money from an IRA or qualified plan during a period of active duty for 180 days or longer don’t have to pay the 10% tax penalty.
There are many other exceptions that could save you from having to pay a penalty on your early retirement distribution. Check out the IRS website for complete details.
If you withdrew funds from a retirement account during this the fiscal year or are planning to in the future, use TaxSlayer when tax season rolls around. We make it easy for you to prepare and file your taxes, no matter your situation.