What are the Tax Penalties for Early Withdrawal on Retirement Accounts?

Litchfield, NH Resident Weight the Pros and Cons

Retirement accounts, from 401(k)s to traditional and Roth IRAs, offer lots of opportunities to grow your money with a tax advantage to boot. Participants in traditional 401(k)s, traditional IRAs, and Roth IRAs are not allowed to withdraw funds before age 59 ½ without penalty. If a hardship or life event makes this early withdrawal necessary, the typical penalty is 10% and the money withdrawn is taxed as income at the time it is received.

A Litchfield resident had been hit with several large bills in recent months and was struggling to get back on his feet. Looking for a way out, he was considering a withdrawal from his retirement account but first wanted to learn the implications for this type of early withdrawal.

Hardship or Life Event as Determined By the IRS

In order to withdraw money from your retirement account early, this will need to be considered a hardship or life event. According to the IRS, this includes certain medical expenses, home buying and principal residence expenses, tuition and fees for up to 12 months, expenses to repair or replace property from a damaged primary residence, and burial or funeral expenses.

If you have other money that could be accessed instead of this withdrawal, including in a bank account, brokerage account, or insurance policy, you may not qualify for this type of hardship withdrawal from your retirement account.

Retirement Account Withdrawals that Do Not Incur a Penalty

Under the SECURE 2.0 act, there is a provision that allows you to withdraw $1,000 annually for emergency personal use without incurring the 10% penalty. However, this money is still taxed as income.

Scenarios that Allow Early Withdrawal for Retirement Accounts

Individuals that are 55 years or older that become disabled, lose their job, are required to pay alimony or child support, or have qualifying medical expenses, may have the 10% penalty waived. They will still be required to pay taxes on the withdrawals as this money will be considered income.

In a perfect world you will wait until 59 ½ (or later) to withdraw money from your retirement account. This will ensure that you do not incur any penalties, while also keeping your retirement savings for when it is needed most. The Litchfield resident was able to find other funds to cover his expenses, ensuring that he avoided penalties and unexpected taxes on the money in his retirement account.