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William Byrnes (Texas A&M) tax & compliance articles

5 Tax Facts for Early Retirement Plan Withdrawals

Posted by William Byrnes on April 28, 2014


In Tax Tip 2014-35, the IRS addressed the issue of potential tax penalties for withdrawing money before retirement age from a retirement account.

5 tax tips about early withdrawals from retirement plans:

1. An early withdrawal normally means taking money from a retirement plan before age 59½.

2. If a taxpayer makes a withdrawal from a plan, that withdrawal amount must be reported to the IRS on the annual tax return.  Income tax may be due as well as an additional 10 percent tax on the amount of the early withdrawal.  The taxpayer may need to file Form 5329, “Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts”, with the annual federal tax return.

3. The additional 10 percent tax does not apply to nontaxable withdrawals.  Nontaxable withdrawals include withdrawals of the cost to participate in the retirement plan.  The cost includes the taxpayer’s after-tax contributions before the contributions are contributed to the plan.

4. A “rollover” is a type of nontaxable withdrawal. Generally, a rollover is a distribution to the taxpayer of cash or other assets from one retirement plan that is then immediately contributed to another retirement plan.  The taxpayer has 60 days to complete the rollover to make it tax-free.

5. There are many exceptions to the additional 10 percent tax. Some of the exceptions for retirement plans are different from the rules for IRAs.

Exceptions to Tax on Early Distributions

Generally, the amounts an individual withdraws from an IRA or retirement plan before reaching age 59½ are called ”early” or ”premature” distributions. Individuals must pay an additional 10% early withdrawal tax and report the amount to the IRS for any early distributions, unless an exception applies.

The distribution will NOT be subject to the 10% additional early distribution tax in the following circumstances: Exception to 10% Additional Tax
Qualified Plans
(401(k), etc.)
IRA, SEP, SIMPLE IRA* and SARSEP Plans Internal Revenue Code Section(s)
Age
after participant/IRA owner reaches age 59½ yes yes 72(t)(2)(A)(i)
Automatic Enrollment
permissive withdrawals from a plan with auto enrollment features yes yes for SIMPLE IRAs and SARSEPs 414(w)(1)(B)
Corrective Distributions
corrective distributions (and associated earnings) of excess contributions, excess aggregate contributions and excess deferrals, made timely yes n/a 401(k)(8)(D),
401(m)(7)(A),
402(g)(2)(C)
Death
after death of the participant/IRA owner yes yes 72(t)(2)(A)(ii)
Disability
total and permanent disability of the participant/IRA owner yes yes 72(t)(2)(A)(iii)
Domestic Relations
to an alternate payee under a Qualified Domestic Relations Order yes n/a 72(t)(2)(C)
Education
qualified higher education expenses no yes 72(t)(2)(E)
Equal Payments
series of substantially equal payments yes yes 72(t)(2)(A)(iv)
ESOP
dividend pass through from an ESOP yes n/a 72(t)(2)(A)(vi)
Homebuyers
qualified first-time homebuyers, up to $10,000 no yes 72(t)(2)(F)
Levy
because of an IRS levy of the plan yes yes 72(t)(2)(A)(vii)
Medical
amount of unreimbursed medical expenses (>7.5% AGI; after 2012, 10% if under age 65) yes yes 72(t)(2)(B)
health insurance premiums paid while unemployed no yes 72(t)(2)(D)
Military
certain distributions to qualified military reservists called to active duty yes yes 72(t)(2)(G)
Returned IRA Contributions
if withdrawn by extended due date of return n/a yes 408(d)(4)
earnings on these returned contributions n/a no 408(d)(4)
Rollovers
in-plan Roth rollovers or eligible distributions contributed to another retirement plan or IRA within 60 days yes yes 402(c), 402A(d)(3), 403(a)(4), 403(b)(8), 408(d)(3), 408A(d)(3)
Separation from Service
the employee separates from service during or after the year the employee reaches age 55 (age 50 for public safety employees in a governmental defined benefit plan) yes no 72(t)(2)(A)(v),
72(t)(10)

NOTE: Governmental 457(b) distributions are not subject to the 10% additional tax except for distributions attributable to rollovers from another type of plan or IRA.

*25% instead of 10% if made within the first 2 years of participation

tax-facts-online_medium

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One Response to “5 Tax Facts for Early Retirement Plan Withdrawals”

  1. There are other methods of retirement planning that can effectively eliminate some early withdraw penalties. We encourage our clients to look into tax free retirement plans as explain in the book “Tax Free Retirement” by Patrick Kelly.

    Like

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