10% Early Withdrawal Tax

Mar 21, 2014 by

tax penaltyIf you’ve got money in a retirement plan, you’re likely well drilled on the early withdrawal rule:

→ Money withdrawn before age 59-1/2 from a retirement plan is subject to a 10% additional tax penalty. ←

That means 10% on top of the normal tax that would apply based on your income.

How the 10% Early Withdrawal Penalty Works

This is important to know. If you desperately need $10,000—and I mean desperately, like to bail your grandmother out of jail—and your retirement plan is literally the only way you can get the cash, and if you’re in the 15% tax bracket, Gramma’s bail is actually going to cost you $13,333. Here’s the math:

$13,333 withdrawn from retirement plan
$ 3,333 Uncle Sam’s cut (that’s 15% + 10% = 25% x $13,333 early withdrawal)
= $10,000 Gramma’s bail money

So Gramma would owe you $13,333.

BUT: Though bail money isn’t one of them, there are many exceptions to the usual 10% tax penalty.

10% Early Withdrawal Penalty Exceptions

Though some rarely apply to the average person, a multitude of exceptions exist to the usual 10% penalty rule. Here’s a handy reference table I swiped from the IRS’ website.

early withdrawal penalty exceptions -1

early withdrawal penalty exceptions -2

early withdrawal penalty exceptions -3

Of particular note:

  • You’ll rest more peaceably knowing that if you die before age 59-1/2, your heirs won’t have to pay the 10% tax penalty if they withdraw all the money from your retirement plan. Perhaps that helps you find more tolerable the prospect of an early death.
  • If you become totally and permanently disabled—and this happens more often than you might like to think—you can make early withdrawals from your retirement account penalty free.
  • A Qualified Domestic Relations Order splits and changes ownership of a retirement plan subsequent to a divorce or legal separation, giving a divorced or legally separated spouse his or her share of the asset. The beneficiary of a QDRO would not be subject to the 10% early withdrawal tax penalty.
  • You can avoid the penalty by setting up what the IRS calls a series of “substantially equal payments”.
  • If you’re using an early withdrawal to pay medical expenses that exceed 10% of your Adjusted Gross Income, no penalty applies.
  • And of course if you roll over an early withdrawal to another retirement plan within 60 days of the withdrawal, you’ll owe no tax, penalty or otherwise.

Want to Learn More About Early Retirement Plan Withdrawals?

If you’re able to read and comprehend IRS resources  (few sane people can), here are some links to more information:

Have You Made an Early Retirement Plan Withdrawal?

Have you ever made an early withdrawal from a retirement plan? If so, did you qualify for an exception or did you have to cough up the 10% penalty?

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