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How to avoid paying the early withdrawal penalty
The Internal Revenue Code penalizes an owner who does not
voluntarily leave the assets in his regular IRA or other retirement plan
until age 59˝ or later. A withdrawal before the date the owner turns
age 59˝ results in an additional tax (over and above any income tax due)
of 10% of the taxable amount of the withdrawal, unless an exception
applies.
Generally, there are no "hardship" exceptions to the 10% additional tax. But
distributions made under the following circumstances are not subject to
the 10% additional tax:
http://www.irs.gov/pub/irs-tege/early_distributions.pdf
http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics---Tax-on-Early-Distributions
- a distribution made on or
after the date on which the employee turns age 59˝;
- a distribution to a
beneficiary (or to the estate of the employee) on or after the death
of the employee;
- a distribution attributable to
the IRA owner's disability;
- a distribution to pay for
medical expenses in excess of 7.5% of adjusted gross income (AGI)
or to pay for medical insurance (without regard to the 7.5% of AGI
floor) if the individual (including a self-employed individual) has
received unemployment compensation under federal or state law for at
least 12 weeks and the withdrawal is made in the year such
unemployment compensation is received or the following year;
- a distribution made to an
employee after separating from service after attaining age 55 (age 50,
in the case of a distribution to a qualified public safety employee
from a governmental plan);
- a distribution of dividends
paid on certain employer securities;
- a distribution from an IRA on
account of an IRS levy;
- a distribution to pay for
"qualified higher education expenses" of the taxpayer, the taxpayer's
spouse, or any child or grandchild of the taxpayer or the taxpayer's
spouse at an eligible educational institution for the taxable year;
- certain "qualified first-time
homebuyer distributions;"
- a distribution which is part
of a series of substantially equal periodic payments
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made not less
frequently than annually over the life (or life expectancy) of the IRA
owner or the life (or life expectancies) of the IRA owner and his
beneficiary; and
- a "qualified reservist
distribution" made during the period beginning on the date the
participant was ordered or called to active duty for a period of at
least 180 days (or for an indefinite period) as a member of a reserve
component and ending at the close of the active duty period.
- a "qualified hurricane
distribution" of up to $100,000 from an eligible retirement plan (as
defined in §402(c)(8)(B)) to an individual who sustained an economic
loss by reason of Hurricane Katrina, Rita or Wilma made during the
applicable period ending before Jan. 1, 2007;
- a distribution of excess
contributions, excess deferrals or excess aggregate contributions
- a dividend paid with respect
to stock owned by a tax credit ESOP or an ESOP if a deduction is
allowed to the employer for such dividends;
-
Inherited IRA Assets - If you are the beneficiary of a deceased person's IRA, amounts you distribute from the inherited IRA are not subjected to early-distribution penalties. This exception does not apply if you are the spouse-beneficiary of the decedent and decide to transfer or roll over the amount to your own non-inherited IRA. To ensure that the IRS knows that the amount is not subject to the early-distribution penalty, your IRA custodian/trustee should report the withdrawn amounts as death distributions by including "Code 4" in box 7 of the IRS Form 1099-R that is used to report the distribution. All inherited IRAs are subject to annual IRS minimum required distribution (MRD) rules, but these are generally based on the inheritor's own life expectancy. This enables holding the investment in an Inherited IRA without the impact of immediate taxes upon death of the decedent, so that you can potentially maximize these inherited assets.
- Distribution due to the disability of a participant - Participant must be disabled within the meaning of IRC section 72(m)(7).
- Distribution as part of a
series of substantially equal periodic
payments
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- Payments must not occur less frequently than
annually. Payments from plans other than IRAs or individual retirement
annuities must not begin before employee separates from service.
- Distribution due to separation
from service. - Does not apply if the separation
from service occurs before the year the participant turns 55. Does not
apply to IRA distributions or to self-employed individuals.
- Distribution less than or
equal to deductible medical expenses. - Does not
apply to pre-1997 IRA distributions.
- Distribution to unemployed
participant for health insurance premiums. -
Applies only to IRA distributions. Participant must have received
federal or state unemployment compensation for 12 consecutive weeks or
have qualified under the self-employment provision. Limited to amount
of health insurance premiums paid.
- Distribution for qualified
higher education expenses of the participant or spouse, or their
children or grandchildren. - Applies only to IRA
distributions. Does not apply if participant qualifies for another
exemption.
- Distribution for the
first-time purchase of a principal residence by the participant or
spouse, or their child or grandchild. - Applies
only to IRA distributions. Distribution must be used within 120 days
to pay qualified acquisition costs. Lifetime limit of $10,000.
Does not apply if participant qualifies for another exemption.
- Distribution subject to loan
agreement. - Loan agreement must be legally
enforceable. Term of loan cannot exceed five years unless distribution
is used to acquire a principal residence. Participant must adhere to
specified repayment schedule and the amount of the loan is limited.
- Distribution made to a
beneficiary or the estate of a participant on or after the
participant’s death. - Only applies to spousal
beneficiary if spouse elects to leave plan assets in participant’s
name rather than rolling them over into IRA established in spouse’s
own name.
- Dividend distribution to ESOP
participant. - Distribution must meet conditions
for dividend deductibility established in IRC section 402(e)(1)(A).
- Distribution pursuant to
federal tax levy on plan under section 6631. -
Does not apply to pre-2000 distributions or distributions used to pay
federal income taxes in the absence of a levy under IRC section 6631.
- Distribution to alternate
payee under a qualified domestic relations order. -
Does not apply to IRA distributions.
- Distribution to federal
retiree electing lump sum credit and reduced annuity. -
Does not apply to lump-sum distribution if
retiree makes the election and retires before the year he or she
reaches age 55. Applies to reduced annuity payment regardless of
age retiree makes election and retires.
- Distribution rolled over into
another qualified retirement plan within 60 days of the distribution.
- IRS can waive the 60-day rollover period if it
believes the participant missed the deadline because of a “hardship”
beyond his or her control.
- Distribution to correct excess
contributions. - Applies to 402(g), 401(k) and
401(m) plans and IRAs.
- Distribution upon conversion
from traditional to Roth IRA. - Applies to
entire distribution (including portion of distribution includable in
income).
Journal of Accountancy - "Withdraw Without Penalty" by Lee G.
Knight and Ray A. Knight
http://www.journalofaccountancy.com/Issues/2005/Aug/WithdrawWithoutPenalty.htm
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Uniform Issue List Code: 72.00-00;
PLR
201323045 (including
Rev. Rul. 2002-62) Penalty does not apply if you are taking a series
of substantially equal distributions from the account for at least five
years and until you have reached age 59˝. But the IRS will treat any
rollover into or out of the IRA during this time as a prohibited change
in payouts which retroactively triggers the 10% penalty on all your
previous withdrawals.
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