Avoiding Early Withdrawal Penalties

Charlotte, in Portland Oregon, asks about avoiding early withdrawal penalties on retirement accounts.

Why would I have to pay an early withdrawal penalty from my retirement account?

  • Retirement accounts or qualified accounts are subject to certain benefits and restrictions.
  • Some the most common qualified account is a 401k, 403b, IRA, 457, TSP.
  • The IRS allows you to deduct your contributions from these plans from your taxes.
  • If you want to withdraw funds from these accounts prior to age 59.5 years old, there could be a potential 10% IRS penalty.

Is there any way to avoid paying?

  • If your distribution prior to age 59.5 is a result of a death, disability, or financial hardship then they could potentially waive the penalty.
  • There is also another way to distribute the funds early without penalty by doing a 72t withdrawal.
  • A loan is another way to take money from your accounts early, but that needs to be paid back with potential interest.

What advice does Ryan for people considering taking early withdrawals?

  • First off, do not take funds from these accounts unless it is unavoidable.
  • If you are thinking about doing a 72t, then make sure that you work with a specialist that can guide you through the process because it can be extremely difficult to do it properly.
  • With the proper planning this situation should be avoidable and unnecessary.

On the latest addition of Summit Financial Partners question and answer series, Charlotte from Portland Oregon, asks Ryan about avoiding early withdrawal penalties on retirement accounts.

When withdrawing money from retirement accounts there are a lot of potential obstacles that could make a serious and significant impact on your financial well-being.  

First off, when we talk about retirement accounts, usually we are talking about qualified accounts. A qualified account could be an IRA, A 401(k), 403B, TSA, just to name a few.

These types of accounts have a lot of benefits to them as well as restrictions, and you need to be aware of both to navigate this tricky landscape.

The IRS allows you to deduct the money that you contribute into these plans from your tax returns. However, when you take this money out, it is fully taxable, both principal and interest. In addition to being fully taxable when you take withdrawals, it could also be subject to a 10% IRS penalty for early withdrawal.

In early withdrawal would be taking funds out prior to the age of 59 1/2 and still working, or 55 years old and separated from service. So, if you consider that these withdrawals are fully taxable, and could carry a 10% IRS penalty as well, these could have devastating consequences to your retirement plan.

However, there are some ways to avoid paying the penalty if you are taking early distributions.

One way is if you have endured a death, disability, or financial hardship. In that case there could be a waiver, so that you are not forced to pay the 10% penalty to the IRS, however it will still be fully taxable.

Another way to avoid paying the 10% IRS penalty could be to do a 72T distribution strategy. The 72T distribution strategy could get you around paying the 10% penalty, but you have basically committed to taking 10 equal and consistent distributions from your account until it is depleted.

The last way to get them funds out without paying the penalty is through a loan. You can take a loan from some of these qualified accounts at an earlier age., But you do have to pay it back and you could be paying interest on the loan as well.

Ryan’s advice for people looking to take early withdrawals from qualified account is very simple. Only do it if it is a last resort and unavoidable.

Furthermore, if you are thinking about doing a 72T distribution strategy then you need to consult a specialist who can guide you through the process. It can be very tricky and difficult to fill out these forms properly and to make sure that everything goes through smoothly.

With the proper planning on taking the right steps having to take early distributions from your timer account should be avoidable.