Owners of qualified retirement plans
must be at least 59.5 years old to take regular distributions from
their accounts. Distributions taken before that age are called early
distributions, and those withdrawals are often subject to a 10% penalty,
in addition to federal income tax. There are some exceptions where the
penalty does not apply.
The IRS defines a qualified retirement plan as one of the following accounts: 401(k), 403(a) and 403(b), as well as 408(a) and 408(b), which are IRA plans. It is important to be clear about what type of account the early distribution comes from, because the rules are slightly different for IRAs.
For all types of qualified retirement accounts, owners do not pay the additional penalty if they are permanently disabled or if they are qualified military reservists serving on active duty for at least six months. Individuals also do not pay the penalty if they incur deductible medical expenses that are more than 10% of their adjusted gross income for the year. Beneficiaries who receive money from the account after the owner dies do not pay the penalty, even if the account owner dies before age 59.5.
The qualified retirement plan distribution rules provide more exceptions for IRA owners. An IRA participant who is a first-time home buyer can take an early withdrawal of up to $10,000 to use as a down payment on a house. An IRA owner can also use early withdrawals for certain higher education expenses and for health-insurance premiums he or she pays while he or she is unemployed. These penalty-free early withdrawals are not available to owners of 401(k), 403(a) and 403(b) plans.
When taking a qualified retirement plan early distribution, account owners must calculate the withdrawal's complete financial impact. In addition to paying a penalty on early withdrawals, account owners must pay federal income tax on the distribution if it comes from an account that was funded with pretax dollars. The distribution is taxed at the account owner's current rate, and a large withdrawal can place the owner into a higher tax bracket, raising the tax rate for both the distribution and the individual's regular income. Most retirement plan administrators withhold 20% from an early distribution to put toward taxes, which means the cash-out check may not be as large as the account owner is expecting. Finally, money that is withdrawn from the retirement account no longer accrues interest, which can have a significant impact on the account over time.
Another option for account holders who are in financial distress is a retirement account loan. A loan that follows lending and repayment rules is not treated as a withdrawal, so it is not subject to income taxes or penalties. Individuals repay their own accounts with interest, which mitigates the impact on long-term account growth.
The IRS defines a qualified retirement plan as one of the following accounts: 401(k), 403(a) and 403(b), as well as 408(a) and 408(b), which are IRA plans. It is important to be clear about what type of account the early distribution comes from, because the rules are slightly different for IRAs.
For all types of qualified retirement accounts, owners do not pay the additional penalty if they are permanently disabled or if they are qualified military reservists serving on active duty for at least six months. Individuals also do not pay the penalty if they incur deductible medical expenses that are more than 10% of their adjusted gross income for the year. Beneficiaries who receive money from the account after the owner dies do not pay the penalty, even if the account owner dies before age 59.5.
The qualified retirement plan distribution rules provide more exceptions for IRA owners. An IRA participant who is a first-time home buyer can take an early withdrawal of up to $10,000 to use as a down payment on a house. An IRA owner can also use early withdrawals for certain higher education expenses and for health-insurance premiums he or she pays while he or she is unemployed. These penalty-free early withdrawals are not available to owners of 401(k), 403(a) and 403(b) plans.
When taking a qualified retirement plan early distribution, account owners must calculate the withdrawal's complete financial impact. In addition to paying a penalty on early withdrawals, account owners must pay federal income tax on the distribution if it comes from an account that was funded with pretax dollars. The distribution is taxed at the account owner's current rate, and a large withdrawal can place the owner into a higher tax bracket, raising the tax rate for both the distribution and the individual's regular income. Most retirement plan administrators withhold 20% from an early distribution to put toward taxes, which means the cash-out check may not be as large as the account owner is expecting. Finally, money that is withdrawn from the retirement account no longer accrues interest, which can have a significant impact on the account over time.
Another option for account holders who are in financial distress is a retirement account loan. A loan that follows lending and repayment rules is not treated as a withdrawal, so it is not subject to income taxes or penalties. Individuals repay their own accounts with interest, which mitigates the impact on long-term account growth.
Culled from investopeadia
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