Anaya Nolan
The Internal Revenue Service (IRS) imposes a 10% additional tax on early withdrawals from retirement plans, including IRAs and 401(k) plans. This tax penalty is designed to discourage individuals from withdrawing funds before reaching retirement age. However, there are exceptions to this rule, which are subject to change over time. For example, in 2024, the IRS introduced two new exceptions for emergency personal expense distributions and domestic abuse victim distributions. Individuals can consult IRS publications and seek advice from tax professionals to understand the specific exceptions and their eligibility.
| Characteristics | Values |
|---|---|
| Early withdrawal age | Before reaching 59 1/2 years |
| Early withdrawal penalty | 10% tax |
| Exceptions to the penalty | Death, disability, certain substantially equal payments, certain post-age 55/50 separation from service, IRS levy, education, home ownership, Roth conversions, etc. |
| IRS form for claiming the exception | 5329 |
| Rollback of funds into an IRA | Allowed once within a rolling 12-month period within 60 days of withdrawal |
| SECURE 2.0 provisions | In-service emergency personal expense distributions and domestic abuse victim distributions |
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What You'll Learn
Emergency personal expense distributions
Generally, individuals who withdraw funds from their retirement accounts before reaching the age of 59½ are subject to an additional 10% early withdrawal tax. However, the Internal Revenue Service (IRS) has recently introduced two new exceptions to this rule, one of which is emergency personal expense distributions.
The IRS Notice 2024-55 provides guidance on this exception, stating that eligible retirement plans can permit these types of distributions. This includes qualified defined contribution plans (such as 401(k) plans), section 403(a) annuity plans, section 403(b) plans, governmental section 457(b) plans, and IRAs. The notice also clarifies that individuals can self-certify their eligibility for these distributions and have the option to repay them within three years.
It's important to note that emergency personal expense distributions are not subject to the 10% early distribution penalty. Individuals can claim this tax relief on Form 1040, and the distribution can be reported on Form 5329. Additionally, the distribution can be repaid within three years to an IRA or other eligible retirement plan.
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Domestic abuse victim distributions
The Internal Revenue Service (IRS) issued guidance in Notice 2024-55 on two new exceptions to the 10% additional tax under Code section 72(t) for early withdrawals from a qualified plan or IRA. These exceptions came into effect on January 1, 2024, and include domestic abuse victim distributions.
For domestic abuse victim distributions, eligible individuals can withdraw up to $10,000 (as indexed for inflation) or 50% of their vested plan balance, whichever is less. These distributions are not treated as eligible rollover distributions, and Code Section 402(f) notices and 20% mandatory income tax withholding do not apply. Plan sponsors can rely on a participant's written certification that the distribution is due to domestic abuse, and participants can repay the distribution within three years if they are eligible to make rollover contributions.
While these new distribution features are optional, even if a plan does not offer a new in-service distribution right, a participant can still take advantage of the relief on their tax return. Formal plan amendments are not required until December 31, 2026, at the earliest.
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Education expenses
Generally, individuals who withdraw funds from their Individual Retirement Accounts (IRAs) before reaching the age of 59 1/2 are subject to a 10% early withdrawal penalty tax in addition to any regular income tax due. This is to discourage the use of IRA distributions for purposes other than retirement. However, there are exceptions to this rule, including qualified higher education expenses.
To be eligible for the penalty exemption, you or your family must have qualifying education expenses within the year you take the distribution. Qualifying education expenses include tuition and other fees charged by the school, the cost of books, supplies, and equipment, and expenses for disability services, if required. If the student attends school more than half-time, the cost of room and board is also covered. It is important to note that any qualifying educational expense paid for in the current year using wages from employment, loans, savings, gifts, or inheritance cannot be offset with IRA funds. Additionally, any expenses funded by tax-exempt scholarships or grants, or expenses paid for with employer or veteran association education assistance, are also excluded.
To avoid paying an early withdrawal penalty, you must show that the student is attending an eligible institution of higher learning. This includes any university, college, vocational school, or other accredited public, private, or nonprofit post-secondary school that is eligible for student aid. You will still be required to pay income taxes due on withdrawn funds. 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.
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Home ownership
Generally, individuals who withdraw funds from their Individual Retirement Account (IRA) or retirement plan before reaching the age of 59 1/2 are subject to a 10% early withdrawal tax penalty. This additional tax is imposed on top of any other taxes that may be owed on the distribution. However, there are several exceptions to this rule, where the 10% penalty is waived, but income tax may still apply.
The early withdrawal of funds from an IRA for home ownership is exempt from the 10% penalty, but it is still subject to income tax. This means that while there is no additional penalty, the withdrawn amount will be included in the individual's gross income and taxed accordingly. Therefore, while the early withdrawal penalty is waived, individuals should be aware of the potential income tax implications of such transactions.
In addition to the home ownership exception, there are numerous other exceptions to the 10% early withdrawal penalty. These include unreimbursed medical expenses, certain health insurance premiums for the unemployed, total and permanent disability, qualified higher education expenses, victims of domestic abuse, and various emergency or disaster-related situations. It is important to carefully review the specific rules and criteria for each exception to understand the eligibility requirements and any limitations on the amount that can be withdrawn without incurring the penalty.
While the home ownership exception provides a valuable opportunity for individuals to access their retirement savings for the purpose of purchasing or constructing their first home, it is important to remember that these funds are intended for retirement. Early withdrawals, even with exceptions, can impact an individual's long-term financial security. Therefore, it is advisable to carefully consider all options and consult a financial advisor or tax professional before making any decisions regarding early withdrawals from retirement accounts.
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Disability
If a retirement account owner becomes disabled, the IRS may waive the 10% early withdrawal penalty. This is applicable to Thrift Savings Plan (TSP) participants and IRA owners. The account owner must show that they are unable to perform any substantial gainful activity, and that the condition causing the disability is expected to result in death or last for a long time. The IRS definition of disability is similar to the definitions used by Social Security and the VA, but there are some differences. The IRS requires a doctor's opinion stating that the individual is totally disabled and will remain disabled permanently or for a long time. However, the doctor's statement does not need to be submitted with the tax return, but it must be available when taking the exception.
The definition of disability per the Internal Revenue Code Section 72(m)(7) is:
> "...an individual shall be considered to be disabled if he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration. An individual shall not be considered to be disabled unless he furnishes proof of the existence thereof..."
Some disabled individuals file IRS Schedule R, Credit for the Elderly or Disabled, with their IRS Form 1040s. This requires a physician's certification that the individual meets the definition of disabled. It is important to note that even if the disability requirement is not met, there are other exceptions to the early withdrawal penalty that may be useful for a person with a disability. For example, there are exceptions for qualified higher education expenses or for victims of domestic abuse.
Additionally, individuals receiving Supplemental Security Income (SSI) benefits should be cautious when withdrawing funds from a retirement account. SSI is a needs-based program with strict resource limits, and withdrawing funds could impact an individual's eligibility for benefits. It is recommended to consult with a local special needs planning attorney or a certified public accountant (CPA) for guidance on specific circumstances.
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Frequently asked questions
A 10% early withdrawal penalty is usually applied to distributions from a retirement plan or IRA if the owner withdraws money before reaching the age of 59 1/2.
Some common exceptions to the 10% early withdrawal penalty include withdrawing to cover educational expenses, permanent disability, home purchases, and more.
Early withdrawals are typically subject to federal and state income taxes, in addition to any regular income tax on the distribution.
To avoid the early withdrawal penalty, you can roll over or transfer the distribution to another IRA or qualified retirement plan within 60 days, as long as it is done once within a rolling 12-month period.
