Whenever you withdraw retirement funds early from your IRA, 401(k), or another retirement savings plan, you must generally include that money as taxable income on your tax return. Early withdrawals might also be subject to an additional penalty tax—as much as 25% under some circumstances. This penalty kicks in when you take a distribution before reaching a certain age (usually 59½).
There are some exceptions to this rule. Keep reading to learn more about the factors and penalties to consider before taking an early withdrawal on your retirement savings.
The Penalty Tax
The penalty tax is normally 10% of the taxable amount 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. That means you'll pay ordinary income tax on the distribution amount in addition to the penalty tax. Taxes are normally withheld from distributions, but if you're also subject to a penalty, the amount withheld might not be enough to cover all your penalty tax.
The penalty increases to 25% if you take the distribution from a SIMPLE IRA within two years of the date you first began participating in the plan.
Exceptions for IRAs
There are a number of circumstances under which someone can withdraw money from an IRA before age 59½. These circumstances include:
- You had a "direct rollover" to your new retirement account by way of a trustee-to-trustee transfer.
- You received a payment, but you rolled the money over into another qualified retirement account within 60 days.
- You were permanently or totally disabled at the time you took the withdrawal.
- You were unemployed and used the money to pay for health insurance premiums.
- You paid for medical expenses exceeding 10% of your adjusted gross income (AGI).
- You paid for college expenses for yourself, a spouse, a dependent, or a grandchild.
- You received the distribution as part of "substantially equal periodic payments" over your lifetime.
- The IRS levied your retirement account to pay off tax debts.
- You're a qualified first-time homebuyer and you took distributions of up to $10,000. This doubles to $20,000 ($10,000 each) if you're married and purchasing a first-time home together.
- The distribution represents a return of nondeductible contributions.
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 penalty. If you take out $15,000, for example, then you'll have to pay a penalty tax on $5,000 of that withdrawal.
Exceptions for 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 total and permanent disability of the plan participant.
- You were age 55 or older and you retired or left your job. This age threshold is reduced to 50 for those who worked for public transportation for state or local governments.
- You received the distribution as part of "substantially equal periodic payments" over your lifetime, but only if you've stopped working for your employer.
- You paid for medical expenses exceeding 7.5% of your adjusted gross income.
- The distributions were required by a divorce decree or separation agreement under the terms of a "qualified domestic relations court order."
- You received distributions of dividends from an employee stock ownership plan (ESOP).
- You are a qualified reservist (this generally applies to reservists who were called into action after the attacks on Sept. 11, 2001).
- 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.
Congress will sometimes extend exceptions for those who were hit by disasters. If you were recently impacted by an extreme weather event, you might want to explore any disaster-related relief options.
You generally won't get hit with a penalty 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. If you did not take a tax deduction for your contributions, and your employer didn't divert funds to your plan before calculating taxes on your pay, then it likely won't trigger a penalty. This often applies to Roth IRA contributions; those contributions are made with after-tax dollars.
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, air traffic controllers, U.S. Capitol Police, Supreme Court Police, and diplomatic security special agents. This rule applies to distributions from governmental retirement plans for employees who separate from service after reaching 50 years of age.
This change was made in 2015 as part of the Defending Public Safety Employees' Retirement Act of 2015.
Reporting the Early Distribution Penalty
Generally, you would calculate the additional penalty on Form 5329 if you qualify for one of the exceptions and your retirement plan did not report the exception in box 7 of Form 1099-R. You don't have to fill out Form 5329 if the exception is properly coded in box 7 of your 1099-R form.
Report the tax on Schedule 2, which must accompany your tax return in tax years 2018 or later.