Early Distribution (December 2016)

Tax Tips

Early Distribution Penalties

By Michael Aston, E.A.
Alhambra Tax Center

When a person is under 59 ½ years of age and receives a distribution from any type of retirement account, there may be a 10% penalty to the IRS and 2.5% penalty to the State of California. Plus…there’s income taxes to be paid on the early distribution.

Here’s an example:

A married taxpayer (age 40) that has taxable income of $80,000, leaves their job, and cashes-out $18,000 from their 401k plan. The $18,000 will be included into the taxpayer’s taxable income ($98,000). Because of this extra income, the married couple will have to pay an extra $4500 to the IRS and $1409 to the State of California in income tax. They also would also have to pay a penalty of $1,800 for the IRS and $450 to the State of California.


So…in this scenario, out of the $18,000 taken out -- $8,159 in additional income taxes and penalties will be paid.


If this happens to you -- rollover the distribution into another retirement account. You have 60 days to roll the distribution into a retirement account to avoid any penalties and additional taxes.

The full amount received in the distribution must be rolled-over into the retirement account. If the distribution was $10,000 and you rolled-over $9,000, you will be assessed penalties and taxes on the $1,000 not rolled-over.

There are some exemptions for waiving the penalties, but you’re still stuck paying income taxes.

·       If you leave your job at 55 or older (50 for public safety employees)

·       Distribution as part of a series of substantially equal periodic payments based on the participant’s life expectancy.

·       Distribution due to the participant’s total and permanent disability.

·       Distribution to a beneficiary on or after the death of the participant.

·       Distribution to pay for unreimbursed medical expenses to the extent they would be allowable as an itemized deduction.

·       Distribution from an IRA to an unemployed individual for health insurance after leaving a job if the individual received unemployment compensation for 12 consecutive weeks.

·       Distribution from an IRA to pay for higher education expenses of taxpayer, spouse, child or grandchild.

·       Distribution from an IRA to purchase as first home, up to $10,000.

·       Distribution due to IRS levy.

·       Qualified reservist distributions from an IRA if called to active duty for a period of at least 180 days.

I would suggest any type of retirement distribution that you receive, you should contact your tax preparer.