Things to Remember When Considering Early Withdrawals
Many taxpayers may need to take out money early from their Individual Retirement Account (IRA) or retirement plan. Doing so, however, can trigger an additional tax on early withdrawals. They would owe this tax on top of other income tax they may have to pay. Here are a few key points to know:
What Is an Early Withdrawal?
Early withdrawals refer to taking a distribution from an IRA or retirement plan before reaching age 59½.
The Additional Tax
- Taxpayers who took early withdrawals from an IRA or retirement plan must report them when they file their tax return.
- They may owe income tax on the amount plus an additional 10 percent tax if it was an early withdrawal.
Nontaxable Withdrawals
- The 10 percent additional tax does not apply to nontaxable withdrawals.
- These include contributions that taxpayers already paid tax on before putting them into the plan.
Rollover Provisions
- A rollover occurs when someone takes cash or other assets from one retirement plan and places it into another.
- Generally, taxpayers have 60 days to complete a rollover to make it tax-free.
Exceptions to the Additional Tax
There are many exceptions to the 10 percent additional tax:
- Some rules for retirement plans differ from those for IRAs.
- Certain scenarios, such as permanent disability, qualified education expenses, or first-time home purchases (specific to IRAs), may qualify.
Disaster Relief
Participants in designated disaster areas may be eligible for relief from the 10 percent early withdrawal tax on distributions from their retirement accounts.
Required Tax Filing: Form 5329
Taxpayers who took early withdrawals last year may need to file Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts, along with their federal tax returns.
Frequently Asked Questions
What qualifies as an early withdrawal from a retirement account?
An early withdrawal typically means taking money out of an IRA or retirement plan before age 59½. These withdrawals may be subject to both regular income tax and an additional 10% penalty tax.
Are there exceptions to the 10% early withdrawal penalty?
Yes. Certain circumstances like permanent disability, qualified education expenses, and first-time home purchases (for IRAs) may qualify for an exception. Rules may vary between IRAs and other retirement plans.
How does a rollover affect early withdrawal taxes?
If you roll over funds from one retirement account to another within 60 days, it is generally not considered a taxable event and avoids the 10% penalty. However, failure to meet the deadline may trigger taxes and penalties.
What are nontaxable withdrawals?
Nontaxable withdrawals include amounts that were already taxed before being contributed, such as after-tax contributions. These are not subject to the 10% additional tax.
What form do I need to file for early withdrawals?
You may need to file IRS Form 5329, “Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts,” along with your federal tax return if you took early withdrawals.