Avoiding the Early Distribution Penalty
By Jeremy T. Rodriguez, JD
Follow Us on Twitter: @theslottreport
To discourage early access to amounts invested in IRAs and company retirement plans, the IRS imposes a 10% early distribution penalty on withdrawals before age 59 ½. Even though Roth IRAs consist of after-tax contributions, the penalty could also apply to converted amounts or earnings. There are several exceptions to the 10% early distribution penalty, which means taxpayers should be familiar with these before electing a distribution. Doing so will help them possibly avoid this penalty.
Unfortunately, the exceptions do not apply uniformly to IRAs and company retirement plans; that would be too easy. Instead, some exceptions apply only to IRAs, others only to company plans, and still others to both! To make this process easier, we’ve created the chart below to track the application of the various 10% penalty exceptions. Use this chart when determining whether an IRA or company retirement plan distribution will trigger the penalty.
Plans and IRAs (including SEP and SIMPLE IRAs)
IRAs Only (including SEP and SIMPLE IRAs)
Annuitizing (72(t) Payments)
Qualified Reservists Distributions
Roth IRA Conversions
Higher Education Expenses
First-Time Home Buyer
Health Insurance (if unemployed)
Age 55 (termination of employment)
Age 50 for Public Safety Employees (termination of employment)
Section 457(b) (governmental plans
Divorce (Qualified Domestic Relations Orders)
Phased Retirement Distributions from Federal Plans
Keep in mind that these exceptions can be combined, so long as the applicable rules and restrictions are met. For example, let’s say a taxpayer has an IRA with a $250,000 account balance. For the 2019 taxable year, the taxpayer withdrawals $40,000 from his IRA. During that same year, the taxpayer’s daughter had $30,000 in higher education expenses and his spouse had $5,000 in medical expenses. If the taxpayer is under age 59 ½, only $5,000 of the withdrawal will be subject to the 10% early distribution penalty (i.e., $40,000 - $35,000 = $5,000).
However, all too often taxpayers misunderstand these rules and get hit with the 10% early distribution penalty. For example, many people with company retirement plans mistakenly believe that the higher education exception applies to their withdrawal (it doesn’t) or that a hardship distribution doesn’t trigger the 10% penalty (it does). Making matters worse is the absence of any relief for these types of mistakes under the Tax Code, plus the fact that courts rarely side with taxpayers on these issues. Therefore, it is vital that taxpayers fully understand these rules prior to taking distributions.
Content Citation Guidelines
Below is the required verbiage that must be added to any re-branded piece from Ed Slott and Company, LLC or IRA Help, LLC. The verbiage must be used any time you take text from a piece and put it onto your own letterhead, within your newsletter, on your website, etc. Verbiage varies based on where you’re taking the content from.
Please be advised that prior to distributing re-branded content, you must send a proof to firstname.lastname@example.org for approval.
For white papers/other outflow pieces:
Copyright © [year of publication], [Ed Slott and Company, LLC or IRA Help, LLC - depending on what it says on the original piece] Reprinted with permission [Ed Slott and Company, LLC or IRA Help, LLC - depending on what it says on the original piece] takes no responsibility for the current accuracy of this information.
Copyright © [year of publication], Ed Slott and Company, LLC Reprinted with permission Ed Slott and Company, LLC takes no responsibility for the current accuracy of this information.
For Slott Report articles:
Copyright © [year of article], Ed Slott and Company, LLC Reprinted from The Slott Report, [insert date of article], with permission. [Insert article URL] Ed Slott and Company, LLC takes no responsibility for the current accuracy of this article.
Please contact Matt Smith at email@example.com or (516) 536-8282 with any questions.