Unforeseen events are just that...unexpected. You started out your career on the right path and began the process of saving for your retirement. Then life throws you a curveball and you realize you will need to access those funds much sooner than you expected. If you have not reached the age of 59½, you will be subject to taxation on withdrawal of those funds and get hit with a 10 percent early distribution penalty. However, there are several exceptions to the penalty. Navigating the exception rules can be tricky because some of them apply only to IRAs, others may only apply to qualified company plans and some apply to both.
- Mary wants to help her daughter pay for college, but at age 46 she would be subject to the 10 percent early withdrawal penalty. Not if she has an IRA. As long as the expenses qualify, Mary will not be subject to the 10 percent penalty [qualified expenses include: tuition, fees, supplies and books; but do not include room and board]. This exception does not apply to company plans.
- Stan worked for the state of Michigan for 30 years and retired at age 53. He would like to surprise his wife with a trip around the world and use some of his retirement funds to pay for the trip. If Stan uses the funds in his public retirement account, he would not have to worry about the 10 percent early withdrawal penalty. If he pulls the funds from his IRA, he won't be that lucky.
- Ursula's sister passed away at the age of 38. Ursula, who is 42, was the sole beneficiary of her sister's 401(k) plan as well as her IRA. Ursula would be able to take a penalty-free distribution from either account. Inherited accounts are never subject to the 10 percent penalty on early distribution.
- Calvin is looking to get out of leasing an apartment and into his own home. He wants to take a distribution from his retirement accounts to make the down payment. If he takes the distribution from his IRA he would not be subject to the 10 percent early withdrawal penalty. This would not be the case if he tried this from his company plan.
- Porsha was seriously injured when her car was hit by another. She was unemployed at the time of the accident and is worried about medical insurance. Lucky for her she is able to withdraw funds from her IRA to pay her medical insurance premiums without having to worry about the 10 percent penalty [permanent disability and unemployment are exceptions to the 10 percent penalty on paying qualified medical expenses; a penalty-free distribution can still be made for qualified medical bills to the extent that they exceed 10 percent of your AGI - this is applicable for IRAs and company plans].
- Alexis, age 56, is unhappy in her marriage and is seeking a divorce from her husband. He has been awarded a qualified domestic relations order (QDRO) that he provides to Alexis to request half of her retirement accounts. Alexis distributes half of her 401(k) plan and half of her IRA to her ex-spouse. Alexis is able to escape the 10 percent early withdrawal penalty on the 401(k) portion, but the distribution from the IRA will be subject to it. QDROs are only applicable to company plans.
When an individual is under the age of 59½ care should be taken to make sure the best decision is made when considering a distribution from a retirement account. Improper planning can lead to additional penalties and taxes that could have been eliminated or at least minimized. To discuss further, contact your professional at UHY LLP in one of our many locations.