Early distribution from retirement accounts

There are times when people really need money, and in those times, a retirement account may seem like a convenient resource to tap. However, there are a few things to consider before taking an early distribution from a tax-deferred retirement plan.

Are you prepared to pay big taxes? If you are younger than 59½, working, and you withdraw funds from your 401(k) or IRA just as you would from a bank account, you could be in for a shock next April. An early distribution from an IRA or a qualified retirement plan will most likely be included in your taxable income. This means that your federal tax bill could balloon for the year in which you take the distribution. (If you take an early distribution from a Roth IRA, you won't be taxed on the amount of your contributions. Any amount above that which is attributable to the Roth IRA's earnings will be subject to tax.)1

What about an additional 10% tax penalty? Along with being taxed, the federal government also places an additional 10% early withdrawal penalty to further discourage premature distributions from your Roth and traditional IRAs, 401(k)s and 403(b)s.1

However, you are exempt from the 10% penalty if you are using the money you withdraw to pay for the following:

  • Deductible medical expenses (documented medical expenses that exceed 7.5% of your adjusted gross income).
  • Higher education expenses (for you, your spouse, or children or grandchildren either of you may have).
  • The purchase of your first home, or the building or rebuilding of a first home.2,3

You are also exempt from the 10% penalty if the following applies:

If you are "totally and permanently" disabled, in the words of IRS Publication 575.2If you are the beneficiary of a deceased IRA owner. If a traditional IRA owner dies before age 59½, neither the owner's estate nor the beneficiary will face the 10% early distribution penalty when those IRA assets are distributed. However, if your spouse dies and you decide to treat an IRA you inherit from him or her as your own, any distribution you take from it before your reach age 59½ may be subject to the 10% penalty.3

Do you really want to do this? As you can see, an early distribution from an IRA or a qualified retirement plan may amount to some very expensive taxes and penalties. It also reduces the invested assets within that retirement account of which could potentially grow and compound over time.

This is why many financial consultants commonly advise their clients against making such a move. Sometimes couples and families feel they have no choice but to draw from their retirement savings, but a conversation with a financial service professional that they know and trust may reveal other options.

Texas Financial

Need investment advice? Give Texans Financial a call at 972.348.2023.

 As featured in Currents / eCurrents Summer 2011 edition


Registered representatives of and securities, advisory services, and insurance products are offered through INVEST Financial Corporation (INVEST), member FINRA/SIPC and affiliated insurance agencies. INVEST is not affiliated with other entities named. Nondeposit investment and insurance products offered through INVEST are not federally insured, involve investment risk, may lose value and are not obligations of or guaranteed by the financial institution.

This material was prepared by Texans Financial, and does not necessarily represent the views of the presenting party, nor their affiliates. This information should not be construed as investment, tax or legal advice. Neither the publisher nor the representative presenting this material is engaged in rendering legal, accounting or other professional services. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. If assistance or further information is needed, the reader is advised to engage the services of a competent professional.

1. advisorone.com/article/irs-top-10-tax-facts-about-early-distributions-retirement-plans [3/2/11]
2. irs.gov/pub/irs-pdf/p575.pdf [2010]
3. irs.gov/pub/irs-pdf/p575.pdf [2010]
4. irs.gov/pub/irs-pdf/p590.pdf [2010]
5. irs.gov/pub/irs-pdf/p590.pdf [2010]
6. montoyaregistry.com/Financial-Market.aspx?financial-market=retirement-income-planning-the-basics&category=3 [4/9/11]

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