Category Archives: Taxable Income

Penalty on Early Distribution from your Retirement Account

Jan 22

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401K

Are you thinking of taking money from your retirement account to satisfy your ever growing thirst for additional money in your pocket? If so, then think again. Because Uncle Sam is going force you to report such distribution as income and even go further to slap you with a 10% Penalty during Tax Season.

Distributions from a 401K Plan, IRA (both Traditional and Roth) or any other Retirement Plans MUST generally be included in your Taxable Income. Additionally a 10% Tax Penalty is added if the distribution is made before you reach age 59 ½ years of age (Don’t ask me why the ½ or not making it just 60years).

The 10% Penalty on Early Withdrawal from Retirement Accounts

The additional tax on an early distribution is 10% of the taxable amount, which in itself is included to your Taxable Income. It is important to consider these consequences before tapping into your Retirement funds prematurely.

Avoiding the 10% Early Distribution Penalty
You can avoid the 10% Penalty under certain conditions outlined below but the inclusion of the distribution in your Taxable Income cannot be avoided.

Reporting the Early Distribution Penalty on your Tax Return
You figure out the additional tax on Form 5239 (Refer to Instructions for completing this form on irs.gov or talk to a qualified Tax Professional. Retirement Plan administrators usually issue Tax payers with a FORM 1099-R whenever they make distributions from their Retirement Accounts and the type of distribution is coded in Box-7. The code in Box-7 specifies the type of exception to the 10% penalty. The exceptions are listed below:

Exceptions to the Early Distribution Penalties
You are not required to pay the additional 10% penalty if you qualify for the following exceptions broken down by the type of Retirement Fund:

Exceptions for Early Distributions from an IRA:

Exceptions for Early Distributions from a 401(K) or 403(b) Plan:
  • You had a “direct rollover” to your new retirement account.
  • You received a lump-sum payment but rolled over the money to a qualified retirement account within 60 days.
  • You were permanently or totally disabled.
  • You paid for college expenses for yourself or a dependent.
  • You were unemployed and paid for health insurance premiums.
  • You bought a house
  • You paid for medical expenses exceeding 10% of your adjusted gross income. Or
  • The IRS levied your retirement account to pay off tax debts.
  • You had a “direct rollover” to your new retirement account.
  • Distributions upon the death or disability of the plan participant.
  • You received the distribution as part of “substantially equal payments” over your lifetime.
  • You paid for medical expenses exceeding 10% of your adjusted gross income.
  • The distributions were required by a divorce decree or separation agreement (“qualified domestic relations court order”).

Distribution Codes for 1099-R Box 7

Distribution Code

Meaning

1

 Early distribution, no known exception –Figure out using FORM 5329

2

 Early distribution, exception applies

3

 Disability

4

 Death

5

 Prohibited transaction

6

 Section 1035 exchange

7

 Normal distribution

8

 Excess contribution

9

 Cost of life insurance protection

A

 May be eligible for 10-year tax option

D

 Excess contribution

E

 Excess annual additions

F

 Charitable gift annuity

G

 Direct rollover

J

 Early distribution from Roth IRA

L

 Loans treated as deemed distributions

N

 Recharacterized IRA contribution

P

 Excess contribution

Q

 Qualified distribution from a Roth IRA

R

 Recharacterized IRA contribution

S

 Early distribution from a SIMPLE IRA in the first two years, no known exception

T

 Roth IRA distribution, exception applies

—Ras Tewu

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