Early Retirement Withdrawals and Your Taxes

Man making an early retirement withdrawal

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. However, when you cash out funds from one of these accounts, you may get hit with a penalty if you do not qualify for an an exception.

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 on top of your regular income tax. The penalty increases to 25% if you withdraw money from a traditional IRA plan within two years of opening the account.

Penalty-free withdrawals

The 10% tax penalty doesn’t apply to certain withdrawals. The most common example is a rollover, which is when you take money out of one plan and transfer it to another plan. Learn more here.

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 leave your job during or after the year you turned 55, you won’t be penalized. You also won’t be penalized if you left or retired from a qualified public safety position during or after the year you reach age 50. This exception is only applicable only for a qualified retirement plan, such as a 401(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 (since IRAs are considered individual retirement accounts).
  • 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 some 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.

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This article was last updated on 4/18/2022.

This article is intended to provide general information to the public and does not provide personalized tax, investment, legal, or business advice. You should seek the assistance of a professional for advice on taxes, investments, and any other financial, legal, or business matter pertinent to your individual situation.

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