Taxes From A To Z: E Is For Early Distributions

Let’s face it… It’s been a tough couple of years for a lot of taxpayers. More and more taxpayers have reached into their savings, including their retirement savings, in order to pay bills and otherwise make ends meet. Unfortunately, pulling that money out before retirement may feel like a good idea at the time but come Tax Day, it can cause a little bit of a headache. This is because the amounts you withdraw from a traditional IRA or another qualified retirement plan before reaching age 59½ are referred to ”early” or ”premature” distributions and are, in most cases, subject to an additional 10% early withdrawal tax in addition to the income tax payable on that amount.

Fortunately, there are some exceptions to this rule. You may not have to pay the early withdrawal penalty if any of the following apply:

• The funds are considered a distribution from a retirement plan other than an IRA as a result of leaving your job and you are over age 55 (age 50 for qualified public safety employees);
• You have unreimbursed medical expenses which total more 7.5% of your AGI;
• Your distributions are less than the cost of your medical insurance or your qualified higher education expenses (IRAs only);
• You are disabled;
• You are a beneficiary of a deceased plan participant or IRA owner;
• You are receiving distributions in the form of an annuity;
• You use the distributions to buy, build or rebuild a first home (IRAs only and limited to $10,000);
• Your distribution is due to an IRS levy (though that stinks);
• Your distribution is a qualified reservist distribution;
• Your distribution is made to an alternate payee under a QDRO;
• The distribution was timely made to reduce excess contributions made under a 401(k) plan, employee or matching employer contributions or elective deferrals (see my related piece on corrective distributions); or
• You are receiving a permissible withdrawal from an EACA (eligible automatic contribution arrangement).

If you don’t meet an exception, you’ll generally report and pay the 10% tax on line 58 of your federal form 1040.

You may also need to file federal form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts (downloads as a pdf) if you’re claiming an exception. You don’t need to file form 5329 if your federal form 1099-R shows distribution code “1” or “J” in Box 7 and you don’t qualify for an exception.

Keep in mind that you will also be treated as having made an early distribution or withdrawal if you don’t make your tax-free rollovers in a timely fashion. The safest bet when making a rollover, when possible, is to make an administrative rollover – in other words, let your administrator/trustee roll the plan directly to another administrator/trustee. Having a check made payable to you opens the door for timing and other issues if you’re not careful (and sadly, occasionally, even when you are).

Retirement plans can be tricky so check with a tax or investment advisor before you start pulling or rearranging accounts even if you think you know what you’re doing. If you make an early distribution/withdrawal, even if you don’t qualify for an exception, be sure and document the transaction well and check with your tax professional so that your paperwork accurately reflects what actually happened. You’d be surprised how many times the paperwork doesn’t really show what happened – that keeps folks like me in business.

Kelly Phillips Erb

Kelly Phillips Erb is a tax attorney, tax writer, and podcaster.

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