Exceptions to the 10% Early-Withdrawal Penalty

Presented by Tim Weller

Withdrawing taxable funds from a tax-deferred retirement account before age 59½ generally triggers a 10% federal income tax penalty, on top of any federal income taxes due. [Distributions from Section 457(b) plans are generally not subject to an early distribution penalty; and the penalty for distributions from SIMPLE IRA plans during your first two years of participation is 25%, 10% thereafter.] However, there are certain situations in which you are allowed to make early withdrawals from a retirement account and avoid the tax penalty. (Check your specific plan provisions to see whether a particular withdrawal option is available.)

IRAs and employer-sponsored retirement plans have different exceptions, although the rules are similar.

IRA exceptions

The following distributions are not subject to the 10% penalty tax:

Death of the IRA owner. Distributions to your designated beneficiaries after your death. Most non-spouse beneficiaries must liquidate the inherited accounts within 10 years.
Disability. Distributions made due to your qualifying disability.
Unreimbursed medical expenses. Distributions equal to the amount of your unreimbursed medical expenses that exceed 7.5% of your adjusted gross income in a calendar year (extended through 2020). (You don't have to itemize deductions to use this exception, and the distributions don't have to actually be used to pay those medical expenses.)
Medical insurance. Distributions made to pay for health insurance if you've lost your job and are receiving unemployment benefits.
Substantially equal periodic payments (SEPPs). Distributions you receive as a series of substantially equal payments over your life expectancy, or the combined life expectancies of you and your beneficiary. You must withdraw funds at least annually based on one of three rather complicated IRS-approved distribution methods. You generally can't change or alter the payments for five years or until you reach age 59½, whichever occurs later. If you do you'll again wind up having to pay the 10% penalty tax on the taxable portion of all your pre-59½ SEPP distributions (unless another exception applies).
Qualified higher-education expenses for you and/or your dependents.
First home purchase, up to $10,000 (lifetime limit).
Qualified reservist distributions. Certain distributions to qualified military reservists called to active duty.
Birth or adoption of a child. Due the Setting Every Community Up for Retirement Enhancement (SECURE) Act, which was passed at the end of 2019, account owners can now withdraw up to $5,000 for a qualified birth or adoption of a child.

Employer-sponsored plan exceptions

The following distributions are not subject to the 10% penalty tax:

Death of the plan participant. Upon your death, your designated beneficiaries may begin taking distributions from your account. Most non-spouse beneficiaries must liquidate the inherited accounts within 10 years.
Disability . Distributions made due to your qualifying disability.
Part of a SEPP program (see above). Distributions you receive as a series of substantially equal payments over your life expectancy, or the combined life expectancies of you and your beneficiary. You generally cannot modify the payments for a period of five years or until you reach age 59½, whichever is longer.
Attainment of age 55. Distributions made to you upon separation of service from your employer. The separation must have occurred during or after the calendar year in which you reached the age of 55 (age 50 for qualified public safety employees).
Qualified Domestic Relations Order (QDRO) . Payments made to an alternate payee under a QDRO.
Medical care (see above). Distributions equal to the amount of your unreimbursed medical expenses that exceed 7.5% of your adjusted gross income in a calendar year (extended through 2020).
To reduce excess contributions/deferrals. Distributions made to correct excess contributions you or your employer made to the plan over the allowable limits.
Qualified reservist distributions Certain distributions to qualified military reservists called to active duty.
Birth or adoption of a child. Due the Setting Every Community Up for Retirement Enhancement (SECURE) Act, which was passed at the end of 2019, account owners can now withdraw up to $5,000 for a qualified birth or adoption of a child.

Special note about COVID-19 distributions

Due to the Coronavirus Aid, Relief, and Economic Security (CARES) Act, penalty-free withdrawals of up to $100,000 from IRAs and employer-sponsored plans may be allowed in 2020 for qualified individuals affected by COVID-19. Individuals will be able to spread the associated income over three years for income tax purposes and will have up to three years to reinvest withdrawn amounts.

If you plan to withdraw funds from a tax-deferred account, make sure to carefully examine the rules on exemptions for early withdrawals. For more information on situations that are exempt from the early-withdrawal income tax penalty, visit the IRS website at www.irs.gov.

The accompanying pages have been developed by an independent third party. Commonwealth Financial Network is not responsible for their content and does not guarantee their accuracy or completeness, and they should not be relied upon as such. These materials are general in nature and do not address your specific situation. For your specific investment needs, please discuss your individual circumstances with your representative. Commonwealth does not provide tax or legal advice, and nothing in the accompanying pages should be construed as specific tax or legal advice. Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2015. Securities and advisory services offered through Commonwealth Financial Network, member FINRA/SIPC, a Registered Investment Adviser.