What are the Early Retirement Account Distribution Rules?

If you need to cover an emergency expense or make a major purchase from a house, you may be thinking about withdrawing money from your retirement account. Depending on your reason for the distribution, you might have to pay a penalty, or you might qualify for an exception.

This post is provided for general information only. Please confirm the details and circumstances of your unique situation with your tax accountant or other appropriate advisor before taking action.

Normal Early Retirement Distribution Rules

These rules apply for early retirement account distributions at all times. This is only a summary of the main ideas, so be sure to talk to your tax advisor or research the details before making any moves.

Traditional IRA

  • Withdrawals before you turn 59.5 are subject to a 10% penalty in addition to ordinary income tax rates.
  • Certain exceptions to the penalty (but not taxes) for education, buying a home, and large medical expenses.

Money in your SEP or SIMPLE IRA is treated the same as a Traditional IRA.

Roth IRA

  • Withdraw contributions at any time without tax or penalty. You need to track how much you’ve contributed to your Roth IRA over your lifetime (your 1099-R won’t show this).
  • If you’ve withdrawn all of your contributions, you can withdraw earnings before you turn 59.5 with a 10% penalty and ordinary income tax rates.
  • Certain exceptions to the penalty (but not taxes) for education, buying a home, and large medical expenses.
  • Money you’ve converted from a Traditional IRA/401(k) counts as earnings for the first five years after conversion. After five years, you can withdraw it the same as Roth IRA contributions.

IRA 60-Day Rollover

For short-term needs, or if you find out you don’t need the money, you can return it to your IRA within 60 days of withdrawing it as if you never took it out. This is intended to let you move money between IRAs rather than as a short-term loan, so there are some rules. You can only do it once (one transaction) within 12 months (not per calendar year).

401(k)

  • Withdrawals always taxed at ordinary income tax rates.
  • 10% penalty on withdrawals before age 59.5.
  • 20% mandatory tax withholding on early withdrawals.
  • Hardship exceptions to the penalty possible but depend on BOTH IRS regulations and your plan rules. In other words, your 401(k) plan might not allow a withdrawal even if the IRS would.
  • Some plans offer loans, but the penalties apply if you can’t pay it back, and you may have to pay the full loan back immediately if you leave your job.
  • If you still have a 401(k) from a previous job, you may be able to roll it over into an IRA to have it treated under the IRA rules.

Roth 401(k)

  • No penalty or tax for withdrawal of contributions.
  • Earnings subject to ordinary income taxes plus 10% penalty for withdrawals before age 59.5.
  • Can’t withdraw contributions only like Roth IRAs — must prorate. E.g., if your account balance is 80% money you contributed and 20% earnings, and you withdraw $1,000, $800 counts as contributions and $200 counts as earnings.
  • Hardship exceptions to the penalty possible but depend on BOTH IRS regulations and your plan rules.
  • Some plans offer loans, but the penalties apply if you can’t pay it back, and you may have to pay the full loan back immediately if you leave your job.
  • If you still have a 401(k) from a previous job, you may be able to roll it over into an IRA to have it treated under the IRA rules.

Special Retirement Account Withdrawal Rules for COVID-19

  • Must have been between January 1, 2020 and June 25, 2021.
  • Must be impacted by coronavirus (either got sick or income loss).
  • Can withdraw up to $100,00 from a 401(k) or IRA without the 10% early withdrawal penalty.
  • Early distributions are still subject to income taxes. You can choose whether to pay the taxes in the same year as normal or spread the taxes over 3 years.
  • Can return the money withdrawn within 3 years. It will work the same as a rollover, and you can only do it if your plan allows rollovers. Can do this in one or more contributions. It will not count against your annual contribution limits.

Conclusion

There are many situations where it might make financial sense to take money out of your retirement account before you retire. Before you do, make sure you understand the taxes and penalties that might apply and have a plan for paying them.

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