Life is complex, and if you find the need to tap into your retirement savings account, you are not alone. In some cases, it may be the right move, or you might not have a choice. According to a recent study, more than half of investors aged 18–34 years have already tapped into their tax-advantaged retirement account.1
IRA and 401(k) accounts are essentially a deal with the government. In exchange for investing for retirement, the government allows preferential and/or deferred tax treatment. If you have not reached the age of 59 ½ yet, most retirement plan distributions from these accounts are considered “premature” and are subject to an extra 10% early withdrawal tax.
So what are the exceptions to the 10% early distribution tax? Navigating these rules may help you avoid substantial additional taxation.2
IRA and 401(k) Early Distribution Penalty Exemptions
The following are considered qualifying exemptions to the 10% early distribution penalty:
- Age. Withdrawals after the age of 59 ½.
- Death. It may be unfortunate to think about, but any withdrawals after the death of the account holder are not subject to penalty.
- Disability. Total and permanent disability of the account owner.
- “Substantially Equal Periodic Payments.” Under Rule 72(t), setting up substantially equal periodic payments for your life expectancy (or your designated beneficiary).3
- IRS Levy. Do you owe the IRS money? You may be able to cover unpaid taxes using a penalty-free withdrawal.
- Medical. This includes unreimbursed medical expenses in excess of 10% of your adjusted gross income (AGI).
- Military. Qualifying distributions to military reservists during active duty.
- Rollovers. Must be properly executed within 60 days.
- Natural Disaster. Some natural disasters receive temporary, event-specific legislation allowing penalty-free withdrawals on a case-by-case basis.4
IRA Early Distribution Penalty Exemptions
- Education. These include tuition, books, supplies and other qualified education expenses for you, your spouse, children and even grandchildren.
- First-time homebuyers may withdraw up to $10,000 without penalty.
- Health insurance premiums incurred during a period of unemployment.
401(k) Early Distribution Penalty Exemptions
- Separation from Service. If separated from service after age 55 (age 50 for certain qualifying governmental public safety employees).
- Loans. If allowed by the plan, you may qualify for a 401(k) loan. It is not a withdrawal, but the account is treated as collateral.
Do It the Right Way!
Documentation is important. Make sure you’re saving records and talking to the right people, such as your office human resources department and your financial professional. Hardship withdrawals may require proof once it’s time to pay taxes. It’s important to also keep in mind that any dollar taken out is a dollar that won’t grow or be available for your future retirement.
If you have to dip into your retirement account, don’t despair. You may have more time to recover than you initially think. Steady progress is important, starting with re-filling your emergency fund and paying off any high-interest debt. Once you’re able, you may want to scale back expenses and set up automatic deposits to ensure that the money is going back into your investment account.
Are you still thinking about making an early withdrawal? Whether your withdrawal falls under the exemption or not, a conversation with a financial professional might be the right place to start.
Click here to schedule a call with a BWC advisor today.
The information presented in this article is obtained from or based on sources believed to be reliable. BWC does not represent or warrant its accuracy or completeness and is not responsible for losses or damages arising out of errors, omissions or changes or from the use of information presented in this article. The article does not purport to contain all the information that an interested party may desire and, in fact, provides only a limited view. Information presented does not constitute an offer to sell or a solicitation of an offer to buy any security.
All investments involve risk, including loss of principal invested. Past Performance does not guarantee future performance. Individual client accounts and performance vary. BWC does not provide tax advice.
About Beirne Wealth Consulting Services, LLC – www.beirnewealth.com
Beirne Wealth Consulting Services, LLC (“BWC”) is a privately owned, SEC Registered Investment Advisor* with offices in Connecticut and Pennsylvania. BWC provides independent, fee-based investment management services and customized financial planning solutions. Our institutional business provides consulting expertise to defined benefit and defined contribution plans, endowments, foundations and non-profit organizations. Our private clients include high net-worth individuals and prominent families, many of whom bring complex wealth management challenges and multigenerational planning needs. For more information, please visit www.beirnewealth.com or give us a call today at 888-231-6372.
*Registration does not imply a level of skill or training.
© 2022 Beirne Wealth Consulting Services, LLC (BWC). All rights reserved. Reproduction or Use without permission is prohibited.