Early Distributions Revisited (May 2018)

Tax Tips

Early Distribution Penalties, Revisited

By Michael Aston, E.A.
Alhambra Tax Center

This past tax season we noticed an increase in early withdraws from retirement account. Many people taking out the money to help purchase a home. When it come to filing their taxes, they discovered that they owe a lot more than expected. Below is an article about Early Distribution Penalties from 2016.

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.