I NEED TO TAKE A DISTRIBUTION FROM MY RETIREMENT PLAN BUT I AM UNDER 591/2 YEARS OLD, HOW WILL IT BE TAXED?

The general rule is if an individual takes a distribution from a retirement plan before age 591/2 then the distribution is taxed by the federal government and an additional 10% early distribution penalty also applies.

Are there any exceptions to the 10% early distribution penalty?

This article is discussing some of the more common exceptions; however it is important to remember that other exceptions do apply. It is also important to remember I am only discussing the 10% early distribution penalty.  Federal and state income tax applies to the distributions whether or not the additional penalty applies.

Medical expense exception – The point to remember here is that the exception will only apply if the distribution does not exceed the deduction allowable on an individual’s federal income tax return.  Currently individuals are allowed to deduct medical expenses in excess of 7.5% of their adjusted gross income (AGI). If an individual has an AGI of $100,000 and medical expenses of $12,000 then the deductible portion is $4,500. This number is calculated as $100,000 x 7.5% = $7,500 subtracted from total medical expenses of $12,000.  An early distribution form a retirement plan would be exempt from the 10% penalty only up to $4,500.

Health insurance payments made by an unemployed individual – The penalty does not apply to an individual for an IRA distribution if the employee pays health insurance for the individual, his/her spouse and dependents. The individual must have received unemployment for at least 12 weeks.

Qualified higher education expenses – This exception only works for IRA distributions. A distribution from any other qualified plan must first be rolled in to an IRA and then distributed to be exempt from the 10% penalty. Qualified higher education expenses are expenses for tuition, fees, books, supplies and equipment required for the enrollment of an individual at an eligible higher education institution.  If the individual is at least a half-time student then room and board are also eligible expenses.  The cost of a computer is not typically eligible unless required by the educational institution.

Qualified first-time homebuyer distribution – This exception only works for IRA distributions. A distribution from any other qualified plan must first be rolled in to an IRA and then distributed to be exempt from the 10% penalty. This applies to individuals and spouses who did not own an interest in a principal residence during the two years prior to a purchase of a home.  The distribution must be used within 120 days to pay the costs of acquiring or constructing a residence.  There is a $10,000 lifetime limit on this exception.

Conclusion

This article gives only a quick synopsis of some of the more common exceptions.  If you are considering taking a distribution form a retirement plan, then I strongly urge that you contact a tax professional well versed in the rules before you take the distribution in order to avoid a 10% penalty.