What are the tax implications of withdrawing from retirement accounts before the age of 59½?

Penalties and Tax Consequences for Early Withdrawal from Retirement Accounts

Early Withdrawal Penalties

1. 10% Additional Tax: Generally, if you take an early distribution from a traditional or Roth IRA before age 59½, you may be subject to a 10% additional tax on the amount that you must include in gross income. This is on top of any regular income tax you may owe on the distribution.

2. 25% Additional Tax for SIMPLE IRAs: If you take a distribution from a SIMPLE IRA within the first two years of participation, the additional tax is increased to 25%.

Reporting the Additional Tax

- The 10% additional tax is reported on Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, and Schedule 2 (Form 1040), Additional Taxes. However, if your Form 1099-R shows distribution code 1 in Box 7, you can enter the 10% tax directly on Schedule 2 (Form 1040) without filing Form 5329.

Exceptions to the 10% Additional Tax

- Unreimbursed medical expenses exceeding a certain percentage of adjusted gross income

- Certain health insurance premiums paid after unemployment

- Disability

- Beneficiary distributions upon the IRA owner's death

- Series of substantially equal periodic payments

- Qualified higher education expenses

- First-time home purchase (up to $10,000)

- IRS levy

- Qualified reservist distributions

- Qualified birth or adoption distributions (up to $5,000)

- Certain emergency or disaster relief legislation

- Corrective distributions

Tax Withholding and Estimated Tax Payments

- Federal income tax withholding is required for distributions from IRAs unless you elect out of withholding. If you choose not to have taxes withheld, you may need to make estimated tax payments to avoid underpayment penalties.

Special Considerations for Certain Types of Retirement Accounts

- Section 457 Plans: Distributions from eligible state or local government section 457 deferred compensation plans are not subject to the 10% additional tax. However, distributions attributable to amounts transferred from other qualified retirement plans may be subject to the additional tax.

- Pensions and Annuities: If you receive pension or annuity payments before age 59½, you may be subject to the additional 10% tax unless the distribution qualifies for an exception.

- Substantially Equal Periodic Payments (SEPPs): If you receive distributions as part of a SEPP, you may be exempt from the 10% additional tax. However, once SEPPs are established, you must adhere to the payment schedule to avoid penalties.

Other Relevant Information

- CARES Act Provisions: The CARES Act provided relief for early withdrawals made by qualified individuals affected by COVID-19, exempting them from the 10% additional tax and allowing for repayment to an IRA or workplace retirement plan within three years.

- Distributions to Victims of Domestic Abuse: For tax years beginning after December 31, 2023, distributions to domestic abuse victims are not subject to the 10% additional tax if certain conditions are met.

It is important to carefully consider the implications of taking an early withdrawal from retirement accounts, including the potential penalties and tax consequences. If you are contemplating such a withdrawal, ensure you understand the rules and exceptions that may apply to your situation.

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Sources:

Topic no. 557, Additional tax on early distributions from traditional ... 2024-08-04

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Topic no. 558, Additional tax on early distributions from retirement ... 2024-08-02

Topic no. 410, Pensions and annuities | Internal Revenue Service 2024-08-02

Substantially equal periodic payments | Internal Revenue Service 2024-08-04

Publication 575 (2023), Pension and Annuity Income 2024-08-03

Important info for people considering making early withdraws from ... 2024-07-30

(IRAs) Arrangements Page 1 of 69 11:55 - 12-Mar-2024 from Individual ... 2024-08-01