CARL WATTS & ASSOCIATES

July 04, 2016

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Early Withdrawals from
Retirement Accounts
  • Distributions made to an alternate payee under a qualified domestic relations order, and
  • Distributions of dividends from employee stock ownership plans.

And here are exceptions for early distributions from an IRA:

  • You had a "direct rollover" to your new retirement account,
  • You received a lump-sum payment but rolled over the money to a qualified retirement account within 60 days,
  • You were unemployed and paid for health insurance premiums,
  • You paid for college expenses for yourself or a dependent,
  • You bought a house (this exception has the following additional criteria: you did not own a home in the previous two-years, and only $10,0000 of the retirement distribution qualifies to avoid the tax penalty).


The additional 10 percent tax normally does not apply to nontaxable withdrawals. Nontaxable withdrawals include withdrawals of your cost in participating in the plan. Your cost includes contributions that you paid tax on before you put them into the plan.

If you transfer a withdrawal from one qualified retirement plan to another within 60 days, the transfer is a rollover. Rollovers are not subject to income tax. The added 10 percent tax also does not apply to a rollover.

You calculate the additional tax on early withdrawals from a retirement account using Form 5329. If the exception is properly coded in box 7 of your 1099-R form, you do not need to fill out Form 5329. If an exception applies and is not recorded in box 7, then you need to fill out Form 5329.

All in all, even with these allowances, it is better to avoid early withdrawals if other alternatives are available. For instance you could borrow against a cash value life insurance policy, tax-free, or against home equity, or cash out of bonds, stocks or mutual funds held outside of retirement accounts. You will be charged capital gains taxes on any profits. To manage the capital gains taxes, try to sell losing positions along with your winners.

Some 401(k) plan sponsors allow you to borrow money from your 401(k); but if you borrow from your 401(k) and lose your job, and you cannot quickly repay the loan, the IRS may treat the loan as an early distribution.

A retirement plan loan must be paid back to the borrowerʼs retirement account under the plan. The money is not taxed if loan meets the rules and the repayment schedule is followed. A plan sponsor is not required to include loan provisions in its plan. Profit-sharing, money purchase, 401(k), 403(b) and 457 (b) plans may offer loans. Plans based on IRAs (SEP, SIMPLE IRA) do not offer loans. To determine if a plan offers loans, check with the plan sponsor or the Summary Plan Description.


Careful planning can usually uncover viable strategies, and scrupulous compliance will avoid potential tax traps.

Even if lack of money is the cause of all this, we strongly recommend that you discuss all your options with a competent qualified professional before making any rash moves.
Retirement is one the most significant events in a person’s life and, with each generation, people are enjoying more and more years of the retirement age. Therefore, it stands to reason that you make sure your retirement is adequately planned for.

Assuming you have your retirement accounts in order, what if something you didn’t plan for happens and you need to make an early withdrawal from a retirement plan? What are the immediate tax consequences of an early distribution?

First of all, let’s get some terms clarified. Generally, early distributions are those you receive from a qualified retirement plan or deferred annuity contract before reaching age 591/2; these early distributions are classified as early withdrawals.

The term "qualified retirement plan" may refer to:

  • A qualified employee plan under section 401(a), such as a section 401(k) plan,

  • A qualified employee annuity plan under section 403(a),

  • A tax-sheltered annuity plan under section 403(b) for employees of public schools or tax-exempt organizations, or
  • An individual retirement account under section 408(a) or an individual retirement annuity under section 408(b) (IRAs).

Withdrawing money from these accounts before due age means that the investment no longer accumulates interest and grows over time. This lost time for the money to compound will substantially shrink your nest egg.

Early withdrawals are taxed as ordinary income, and to discourage even more the use of retirement funds for purposes other than normal retirement, the law imposes a 10% additional tax on certain early distributions from certain retirement plans. The additional tax is equal to 10% of the portion of the distribution that is includible in gross income.

Besides the potential 10% early withdrawal penalty from a tax-qualified plan, any lump-sum distribution from a retirement plan sponsored by your employer (including 401k, 403b, SEP, defined benefit and cash balance plans) is subject to a 20% tax withholding.

But, what would a rule be without exceptions, right? So, even if an early distribution will still be taxed as ordinary income, there are a number of exceptions to the 10% additional tax.


The following exceptions apply to early distributions from any qualified retirement plan:

  • Distributions made to your beneficiary or estate on or after your death;
  • Distributions made because you are totally and permanently disabled;
  • Distributions made as part of a series of substantially equal periodic payments over your life expectancy or the life expectancies of you and your designated beneficiary;
  • Distributions to the extent you have deductible medical expenses that exceed 10% of your adjusted gross income (7.5% if you or your spouse is age 65 or over) whether or not you itemize your deductions for the year. The 7.5% limitation is effective only from January 1, 2013 to December 31, 2016 for individuals age 65 and older and their spouses;
  • Distributions made due to an IRS levy of the plan under section 6331;
  • Distributions that are qualified reservist distributions. Generally, these are distributions made to individuals that are called to active duty for at least 180 days after September 11, 2001.

There are additional exceptions which apply only to early distributions from a qualified retirement plan other than an IRA:

  • Distributions made to you after you separated from service with your employer if the separation occurred in or after the year you reached age 55, or distributions made from a qualified governmental defined benefit plan if you were a qualified public safety employee (State or local government) who separated from service on or after you reached age 50,
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