Early Withdrawals from Retirement Plans & Tax Implications

Pittsburgh Tax Service

In order to encourage American taxpayers to save for their retirement, the government has enacted tax breaks for contributing to retirement plans while simultaneously assessing penalties for early withdrawals from retirement plans.  Generally speaking, early withdrawals are any money taken from a qualified retirement plan before the age of 59 and a half.  Further, a qualified retirement plan is defined as a traditional IRA or Roth IRA, employee retirement plan like a 401(k), employee annuity plan like a 403(a), or a plan for employees of tax-exempt organizations and tax-exempt organizations like a 403(b). 

Our North Hills / Pittsburgh Accounting & Tax Experts can help you determine the tax implications of early withdraws from your retirement account! Contact us today at (412) 931-1617. 

Unless a taxpayer takes advantage of an exception, an early withdrawal is added to gross income and taxed at the taxpayer’s effective tax rate.  Moreover, the taxpayer owes an additional tax as a penalty, equal to 10% of the amount added to gross income.  This penalty is paid alongside regular income tax, and can result in a taxpayer owing money when they file their taxes.  These penalties are not assessed on amounts rolled from one qualified plan to another.

Fortunately, there are exceptions to the 10% penalty.  If using one of these exceptions, a taxpayer must still report the withdrawal as income, but the law does not mandate the imposition of the 10% penalty.  Some of these exceptions include distributions made to the taxpayer’s estate or beneficiary after their death; distributions made because a taxpayer is totally and permanently disabled; distributions made to pay for Internal Revenue Service levies; withdrawals taken to cover qualified post-secondary education expenses; withdrawals taken to cover deductible medical expenses; withdrawals as a  Qualified Reservist Distribution; and distributions made as an installment in a series of equal payments over the taxpayer’s life expectancy, or over the life expectancy of the taxpayer’s beneficiaries. If the retirement plan is not an IRA, the taxpayer must have left employment before commencing payments.  Further, there are exceptions that apply specifically to whether or not the qualified plan is a traditional or Roth IRA, which can be discovered and applied by an accountant or other qualified tax preparer.

When filing taxes, reporting an early withdrawal is a simple process.  A taxpayer will receive Form 1099-R and report the total from box 2 on Form 1040, as early withdrawals preclude usage of Forms 1040EZ or 1040A.  Finally, the taxpayer usually must also fill out Form 5329, which shows the calculation of the additional tax penalty or usage of an exception as applicable.  If you have any questions regarding early retirement withdraws, give our tax experts a call!