Taking Funds Out of Retirement Plans Early

Are you thinking of taking an early distribution from your 401(k) or other retirement plan?  If yes, this is the time to read up on early distribution rules.  In Tax Tip 2011-42, available at www.irs.gov, the IRS reminds everyone of the tax impact of taking a withdrawal from a retirement plan before reaching age 59 ½.

Early distributions are generally subject to an additional 10% tax than if a person waited until 59 1/2.  A person who takes an early distribution must report this 10% tax on the proper line of Form 1040 and may be required to file Form 5329 “Additional Taxes on Qualified Plans (Including IRAs) and other Tax-Favored Accounts”.  This form is also found on the IRS website, under forms for individuals.

Distributions from qualified retirement plans such as 401(k) plans are subject to federal income tax withholding.  However, depending on what tax bracket a person is in, the withholding may not be enough.  This means, the person may have to make estimated tax payments.  Estimated taxes are due each quarter.  If a person does not pay the estimated taxes on time, the person may be penalized, even though throughout the entire year, the person pays the proper amount of taxes, or gets a refund after filing taxes in April.

There are situations where a New Yorker can take an early distribution without incurring the 10% tax.  The 10% tax does not apply if you roll the distribution over to another IRA or other qualified retirement plan like when you switch employers and roll over the funds to the 401(k) plan of a new employer.  Though, the rollover needs to be completed within 60 days of the date you received the distribution.  The 10% tax does not apply if you use the distribution to buy a first home, to pay certain medical or education expenses, or if you are disabled.

While there are exceptions that let you to take an early distribution without incurring the 10% tax, let your nest egg grow if you can to ease into the golden years, especially when there are no children who are around to contribute.  Each person’s situation should be reviewed carefully before deciding to take out funds from retirement savings.  To get more information about early distributions:

  • Tax on Early Distributions from Retirement Plans, Other Than IRAs:  http://www.irs.gov/taxtopics/tc558.html
  • Tax on Early Distributions from Traditional and Roth IRAs:  http://www.irs.gov/taxtopics/tc557.html
  • Pensions and Annuities:  http://www.irs.gov/pub/irs-pdf/p575.pdf
  • Individual Retirement Arrangements (IRAs):  http://www.irs.gov/pub/irs-pdf/p590.pdf

Or contact an experienced tax attorney in New York.